Question

Please, answer the question correctly. The answer should have some critical thinking and class concepts (Corporate Financial Management). Do not exceed 750 words. You are allowed to cite websites and have references. Thanks.

Firms sometimes use the threat of bankruptcy filing to force creditors to renegotiate terms or even as a means of reducing labor costs. Whether or not this move is ethical or proper is often debated. What say you? What does the company expect by doing so?

Answer 1

It is correct that company’s sometime resort to the threat of filing bankruptcy proceedings to re-negotiate the terms of debt with the creditors and with labor union. If the company files for bankruptcy proceedings then the court intervenes and the asset of the company will be sold and distributed to the creditors on the priority basis. The idea is that if the company chooses to file bankruptcy then employees will lose job and the creditors will have to accept the share of the salvage value and in these circumstances the assets are normally do not sold at the fair value of the asset and all the stakeholders be it company, employees or creditors all will be at disadvantage. Sometime the company believe that creditors are taking advantage of the situation and charging far more higher interest rate then they should be charging and the company believes that by restructuring some of its debt turnaround is possible so the company will resort to such tactics. The company management understands that creditors would not want the company to file for bankruptcy. This tactic is used only when the company is in distress and the management believes that the turnaround is possible after the restructuring of the debt but if the management is dishonest then they would resort to such tactics to protect their jobs in the short term. This approach is not unethical depending on the circumstance but the companies which does follow this tactic they will lose creditworthiness in the market and their market value will be impacted, their cost of debt will go up so not always company follow these methods. In the case of labor union, the company wants to reduce the cost of manufacturing so they would resort to such methods so that employee’s productivity increases and the cost of production decreases. This move is certainly not unethical if the management intentions are to turnaround the company by increasing productivity. The major reason for negotiations with creditors as well as labor unions is to reduce the cost of operation so that the cost can be decreased and the overall productivity can be achieved. Normally when this happens the new management is brought in and that will discuss the issue with creditors as well as employee representatives to so that in the long-term company can be financially sustainable and everybody benefits from it.