Question

Explain whether an investor would be better off being an investor in a corporation’s common stock or in the firm’s bonds in the event the firm faces bankruptcy and liquidation through a “fire sale” auction.

Answer 1

In case of bankruptcy and liquidation, the order of preference in which claims are settled are :

• Creditors - they are paid off first before claims of stockholders
• Preferred stock - they are paid off after creditors but before common stockholders
• Common stock - they are paid last, after the claims of creditors and preferred stockholders are settled

Therefore, it is better off being an investor in a corporation’s bonds in case of bankruptcy and liquidation because bondholder's claims are settled before the claims of common stockholders.