Can Creditors Restrict Managerial Investment Behavior in Distressed Firms?

Shareholders in distressed firms should profit from shifting to more risky assets, but there is little empirical evidence documenting such behavior. We find that this weak evidence is consistent with creditors being somewhat able to control the investment policies of distressed firms if distress is detected in a timely fashion. We use the number of years to future bankruptcy as a proxy for true distress, and various measures based on current financial statements and stock market data to proxy for perceived distress, and we show that only firms that manage to conceal their health issues risk-shift. Further evidence indicates that creditors have control over the investment behavior of known distressed firms through both covenant restrictions and these firms' continuous financing needs. International data further support our conclusions