Question

When a company defaults on its debt, debtholders often received 50% or less of the amount they are owed, as well as lost interest. Is the difference between the amount debtholders are owed, and the amount they actually receive as cost of bankruptcy?

Answer 1

Answer - NO

The bankruptcy cost could vary for different types of firms, but they fall under two heads – direct and indirect

Direct Costs - Direct cost involves cash outlays, like accounting fees, legal fees, losses due to the sale of assets at distressed prices, the rise in the borrowing cost due to the poor credit rating and also exit of the valuable employees. It may also include fees paid to administrators, liquidators, lawyers, accountants, and investment bankers.

Indirect Costs - Indirect costs are those which does involve cash outflow but makes the survival of the company or a person tougher. Bankruptcy cost can impact intangible assets, like staining the goodwill of the company, loss of market share, loss of customers trust and suppliers tightening credit terms

Therefore;

The difference between the amount debtholders are owed, and the amount they actually receive is NOT cost of bankruptcy But the Loss which is beared by Bondholders & Hence not a part of Bankruptcy costs of the company - It is the personal loss of the Bondholder of his Investment made in the company.