Question

Discuss a case in which equityholders benefit from defaulting loans even though the firm is financially solvent. (You can assume that equityholders can renegotiate the terms of defaulted loans with debtholders.)

Answer 1

If a company default in payment of loan then following consequences may occur

• Lender may file application for insolvency

• Default may create wrong image of company in the market

• Customers and lender will loss faith in company

• Refinancing option from other sources may be difficult

If the company default the loan, the management will be eager to refinance the loan and to come out of situation of default any how.

The relative fixed cost ( interest ) will have to be adhered before making any negotiation with any source of finance.

The management will be more positive toward replacing fixed interest loan with, either low interest rate loan or without any finance cost i.e equity issue.

Management will relook the business process in order to determine the main factors behind those default, it will examine efficiency of existing processes, will advance existing processes, will address new processes.

The deep analysis of business will be benefit to company and thereby to equity shareholders.

The continuous finance cost which were accruing day by day will be decreased or eliminated.

This will, definitely have positive consequences for the equity shareholders. Since company is ultimately owned by equity shareholders, hence they will be mainly impacted by it.

Renegotiation will be on eased terms w.r.t finance cost and term of repayments.

As someone said , incase of failure the best from men can be derived.

Please share your valuable inputs.