Question

6. Financial distress has multiple negative consequences for the companies, and if they have high business risks their assets are easily destroyed in financial distress. State some example of these assets that particularly sensitive to the financial distress and why?

Answer 1

Firms are more likely to be affected by financial distress, if they have high business risks. Such risk arises when the earnings of the company are sensitive to the fluctuations of the economy. The companies may have assets which are easily destroyable in financial distress. In such companies the financial distress cost will be high.

Example of assets that particularly sensitive to the financial distress are human capital and intangibles. That is the employees and the customers. If they are not satisfied, they may leave the company or seek competitors. If the company has tangible assets, that can be sold in the case of financial distress. Thus the firms with tangible assets are more leveraged than the companies with intangible assets.