Transactions Costs and Capital Structure Choice: Evidence from Financially Distressed Firms



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    • Harvard Business School. I am especially grateful to Harry DeAngelo, Linda DeAngelo, Richard Ruback, René Stulz, and two anonymous referees for making many constructive suggestions that greatly improved the article. I thank Edie Hotchkiss for generously allowing me to use her data on liquidation costs. Finally, I thank the following for their helpful discussions and comments: Barry Adler, Ed Altman, Sanjiv Das, Steve Fenster, Julian Franks, Ken Froot, John Graham, Max Holmes, Ken Klee, Josh Lerner, Lynn LoPucki, Ron Moore, Hank Reiling, Paul Seguin, Dennis Sheehan, Erik Sirri, Randall Thomas, David Thompson, Walter Torous, Peter Tufano, Mike Vetsuypens, Elizabeth Warren, Jay Westbrook, Luigi Zingales, and seminar participants at Boston College, Harvard Business School, the Jönköping International Workshop on the Law and Economics of Bankruptcy and Financial Distress, Michigan, the National Bureau of Economic Research, North Carolina, Ohio State, Rutgers, Southern California, Texas at Austin, Vanderbilt, Virginia Polytechnic, Wharton, Yale Law School, the 1994 Meetings of the Association of Managerial Economists, and the 1994 Meetings of the Western Finance Association. Jeremy Cott and Samuel Karam provided invaluable research assistance. The Division of Research at the Harvard Business School provided financial support.


This study provides evidence that transactions costs discourage debt reductions by financially distressed firms when they restructure their debt out of court. As a result, these firms remain highly leveraged and one-in-three subsequently experience financial distress. Transactions costs are significantly smaller, hence leverage falls by more and there is less recurrence of financial distress, when firms recontract in Chapter 11. Chapter 11 therefore gives financially distressed firms more flexibility to choose optimal capital structures.