We report that 31% of the firms completing leveraged recapitalizations
between 1985 and 1988 subsequently encounter financial distress. Foll
owing their recaps, the distressed firms exhibit (1) poor operating pe
rformance due largely to industry-wide problems, (2) surprisingly low
proceeds from asset sales, and (3) negative stock price reactions to e
conomic and regulatory events associated with the demise of the market
for highly-leveraged transactions. The incidence of distress is not r
elated to several characteristics that have previously been linked wit
h poorly-structured deals. We thus attribute the high rate of distress
primarily to unexpected macroeconomic and regulatory developments.