Trade Receivables Policy of Distressed Firms and Its Effect on the Costs of Financial Distress

Authors


  • We thank Sheridan Titman, Andres Almazan, Maximiliano González, Jay Hartzell, Ross Jennings, Robert Parrino, Roberto Wessels, and the seminar participants at the University of Texas at Austin, IAE Business School—Universidad Austral, the Instituto de Estudios Superiores de Administración—IESA, the Pontificia Universidad Católica de Chile, and the 2006 Global Finance Conference in Rio. Carlos A. Molina thanks financial support from Fondecyt Program-Chile (project 1051021). Valuable suggestions from William G. Christie (the Editor) and an anonymous referee have also significantly improved the paper. Part of this research was conducted while Carlos A. Molina was at the Pontificia Universidad Católica de Chile and Lorenzo A. Preve was at the University of Texas at Austin. All the remaining errors are our own.

Abstract

This paper studies the trade receivables policy of distressed firms as the trade-off between the firm's willingness to gain sales and the firm's need for cash. We find that firms increase trade receivables when they have profitability problems, but reduce trade receivables when they have cash flow problems. We also find that a firm that significantly cuts its trade receivables when in financial distress will experience an additional drop of at least 13% in sales and stock returns over the previously documented 20% average drop for financially troubled firms. Moreover, the performance decline of a firm in financial distress is significantly higher if the firm cuts trade receivables than if it does not.

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