TRANSACTIONS COSTS AND CAPITAL STRUCTURE CHOICE - EVIDENCE FROM FINANCIALLY DISTRESSED FIRMS

This study provides evidence that transactions costs discourage debt r eductions by financially distressed firms when they restructure their debt out of court. As a result, these firms remain highly leveraged an d one-in-three subsequently experience financial distress. Transaction s costs are significantly smaller, hence leverage falls by more and th ere is less recurrence of financial distress,, when firms recontract i n Chapter 11. Chapter 11 therefore gives financially distressed firms more flexibility to choose optimal capital structures.