Do firms engineer “toxic” capital structures to stave off bankruptcy?
In Stayin’ Alive: Debt Complexity as a Bankruptcy-Delaying Mechanism, recently accepted for publication in Journal of Corporate Finance, Håkan Jankensgård of Stockholm Business School, with co-authors Jens Forssbaeck and Reda Moursli, investigate how financially distressed companies use complex debt structures to prolong their survival.
The study finds that as companies encounter financial difficulties, they often increase the complexity of their liabilities, adding multiple layers of debt across various legal entities. This complexity creates uncertainty about creditor claims in the event of bankruptcy, making legal proceedings costly and time-consuming. Faced with these heightened costs and uncertainties, creditors may be reluctant to push a company into bankruptcy.
Associate Professor Håkan Jankensgård
Instead, they often prefer to renegotiate or extend terms, effectively giving struggling firms additional time to recover. The research confirms that firms with more complex debt structures are significantly less likely to go bankrupt, even when controlling for their underlying financial health.
Interestingly, the study also examines how debt complexity affects borrowing costs. Initially, diversifying sources of debt can reduce a firm’s cost of borrowing. However, as complexity increases beyond a certain point, borrowing costs rise, reflecting lenders’ concerns about the risks and challenges associated with overly complicated financial arrangements.
The findings offer new insights into corporate behaviour during periods of distress. They suggest that rising debt complexity is not just a side effect of financial trouble but may be a deliberate strategy to avoid bankruptcy. This research contributes to a deeper understanding of financial distress management and highlights important implications for creditors, investors, and policymakers alike.
