HOW COSTLY IS FINANCIAL (NOT ECONOMIC) DISTRESS - EVIDENCE FROM HIGHLY LEVERAGED TRANSACTIONS THAT BECAME DISTRESSED

This paper studies thirty-one highly leveraged transactions (HLTs) tha t become financially, not economically, distressed. The net effect of the HLT and financial distress (from pretransaction to distress resolu tion, market- or industry-adjusted) is to increase value slightly. Thi s finding strongly suggests that, overall, the HLTs of the late 1980s created value. We present quantitative and qualitative estimates of th e (direct and indirect) costs of financial distress and their determin ants. We estimate financial distress costs to be 10 to 20 percent of f irm value. For a subset of firms that do not experience an adverse eco nomic shock, financial distress costs are negligible.