Question

Since the late $\mathbf{\text{1990s}}$, more than $\mathbf{\text{25}}$domestic steel companies have filed for bankruptcy. A combination of low prices with strong competition by foreign competitors and so-called “legacy costs” of unions are cited as the primary reasons why so many steel companies are filing for bankruptcy. In $\mathbf{\text{2002}}$ , as Brownstown Steel Corp. was in the process of restructuring its loans to avoid bankruptcy, its lenders requested that the firm disclose full information about its revenues and costs. Explain why Brownstown’s management was reluctant to release this information to its lenders.

Short answer

If the information is withheld, creditors may be more ready to give more favorable debt restructuring terms, allowing the company to avoid bankruptcy and continue functioning.

Step-by-step solution

Debt Restructuring Process 

A debt restructuring procedureis initiated when a firm experiences liquidity issues and wants to set new terms for the payment of interest on its present debt through renegotiation with the creditor. It is done when an entity faces financial glumness.

The name suggests that the process involves reconstituting the loans taken by an entity which it is unable to repay at the agreed time period. Thus, this method is used by both government and financial entities like an individual, or a firm or an industry

Step 2: Reluctance to release information to lenders

Brownstown Steel Corp's manager is keeping information regarding the company's financial accounts from its creditors, creating a moral hazard issue. Unlike the scenario that may occur if the creditors knew comprehensive financial knowledge about the firm, this circumstance will benefit the company by giving it negotiation leverage over the debt.

Preventing the disclosure of this information may result in creditors offering more favourable debt restructuring terms, allowing the company to avoid bankruptcy and continue in operation. If there was no information asymmetry and creditors had access to the company's revenue and spending, they would almost certainly decide to have them file for bankruptcy in order to safeguard their capital.

Therefore,by withholding this information, creditors are more willing to grant more favorable debt restructuring terms, allowing the firm to avoid bankruptcy and continue operations. If there was no information asymmetry and creditors had access to the company's revenue and spending, they would almost likely file for bankruptcy to protect their assets.