Leverage Relationships and Respond to Distress

Companies with poor business performance tend to perform operational actions such as change of top management, asset restructuring and dismissal of employees. Analysis of the reaction when the company experienced a bad short-term performance can explain how sensitive the company took the decision in the face of possible bankruptcy. By responding more quickly, the company’s value can be maintained and bankruptcy can be avoided.

Leveraged firms with a higher value, the company will go down faster than the companies that have leveraged lower. Where the impairment, may mean a failure in the company.

This study analyzes the relationship between capital structure with operational and financial performance of companies in response to a failure. Jensen refers to the argument that greater debt will increase the chances of actions by the company to overcome the poor performance of the short term.

Various models are used to examine the relationship between corporate capital structure (debt-to-equity ratio, managerial holdings as well as the actions of the company). Poor performance and declining value of the company demanded a quick response from the company. One of them by taking operational measures, such as (1) changing the structure of assets by selling assets, closing the division, and stop the operation is not profitable, (2) change the size and scope of operations by consolidating production facilities and firing employees, and (3) changing the structure top management. Jensen said that there is a positive relationship between leverage and operational action firms with poor performance.

Action to further the company’s operations can be further classified based on the income achieved by the company (or not). Some models use traditional free cash flow argument to predict a positive relationship between leverage and operating companies that produce short-term cash flow.

Jensen says that companies with higher leverage will restructure their debts while the company’s value down. In addition to responding operationally, the company also responded to the poor performance of financial services companies with dividend cuts. Dividend cuts made to maintain the company’s internal funds for routine operations. The study also examined whether the level of debt before the decline in corporate performance associated with a decision on the dividend announcement.