Managing Bankruptcy and Default Risk

• Date: 01 November 2014
• DOI: http://doi.org/10.1002/jcaf.22002
• Published date: 01 November 2014
• Author: Peter Woodlock,Ramesh Dangol

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© 2014 Wiley Periodicals, Inc.

Published online in Wiley Online Library (wileyonlinelibrary.com).

DOI 10.1002/jcaf.22002

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Peter Woodlock and Ramesh Dangol

Managing Bankruptcy and Default Risk

INTRODUCTION

Two iconic Ameri-

can firms, General

Motors (GM) and

Eastman Kodak Cor-

poration (Kodak),

filed for Chapter 11

bankruptcy protec-

tion in 2009 and 2012,

respectively (Beaudette

& Palank, 2013; Welch,

2009). The effects of

GM and Kodak’s

bankruptcies reverber-

ated across their supply chains.

Following GM’s bankruptcy

filing, some of GM’s suppliers

such as Lear Corporation, Del-

phi Corporation, and American

Axle & Manufacturing Hold-

ing Incorporated either filed for

Chapter 11 bankruptcy or faced

severe financial pressures (Trott-

man, Spector, & Stoll, 2009).

Similarly, Kodak was expected

to pay only $66 million to its

unsecured creditors, to whom

they were estimated to owe

between $1.6 and $2.2 billion

(Beaudette & Palank, 2013). The

GM and Kodak bankruptcies

show that a firm can be exposed

to bankruptcy and default

risks not because it makes poor

business decisions, but rather

because the firm’s suppliers and

customers fail to make prudent

business decisions.

Given that a firm can face

bankruptcy and default risks

when its key suppliers and

customers file for bankruptcy

protection and when a firm in

which it has made substantial

investments files for bankruptcy

protection, it is important for

management to be able to pre-

dict potential bankruptcies and

develop strategies to limit finan-

cial risks resulting from supplier

and/or customer bankruptcies.

Therefore, the purpose of this

article is twofold; first, we dis-

cuss various default/bankruptcy

scoring models that a firm can

use to measure its bankruptcy

and default risk for its key

customers, key suppliers, key

investees, and others with whom

the firm transacts. Second, we

highlight strategies a firm can

employ to limit bankruptcy and

default risk exposure

that accompany

bankruptcy filings

by the firm’s key

suppliers, customers,

and others.

There are two

external sources

that can negatively

contribute to a firm’s

bankruptcy and

default risks. First,

a firm’s bankruptcy

and default risks

can increase when a

firm’s suppliers and/or custom-

ers file for bankruptcy protec-

tion. A loss of a key supplier can

cause significant disruptions in

the firm’s operations, thereby

limiting its ability to offer goods

and services in the marketplace.

In contrast, a loss of a firm’s

key customer can curtail the

firm’s sales, thereby reducing

the firm’s both immediate and

longer term cash flows. Second,

a firm’s bankruptcy and default

risk increases when a firm in

which it holds substantial invest-

ments (investee) either files for

bankruptcy protection and/

or defaults on its debt. Since

a firm’s financial fate is deter-

mined not only by the firm’s

own business decisions, but also

by those of its suppliers, custom-

ers, and investees, it is imperative

that the firm manage its own as

Understanding and managing bankruptcy and

default risk is a treasury imperative. The authors

discuss various default/bankruptcy scoring mod-

els that a firm can use to measure its bankruptcy

and default risk for its key customers, key sup-

pliers, key investees, and others with whom

the firm transacts. Then, they highlight strate-

gies a firm can employ to limit bankruptcy and

default risk exposure of bankruptcy filings by

the firm’s key suppliers, customers, and others.

© 2014 Wiley Periodicals, Inc.