Capital structure decision-making for business turnarounds based on distress severity and reasonable prospect confluence

Abstract

BACKGROUND : The relationship between financial distress severity and the prospect for rescuing a distressed company significantly impacts capital structure decisions. When a company faces distress, its interactions with funders change, directly affecting rescue prospects. AIM : This research proposes objective frameworks to assess distress severity and rescue prospects, aligning them with practical capital decisions. SETTING : This study, set in South Africa with its nascent financial distress legislation and industry, proposes new frameworks to assess distress severity and the likelihood of company rescue. These findings align with capital structure theory and have applications beyond South Africa. METHOD : Using Q-methodology to understand how the confluence between distress severity and rescue potential is crucial for capital structure decisions in business turnarounds. RESULTS : The factor array and loadings point to a confluence of distress severity and the prospects to rescue a business and align with the three main capital structure theories of irrelevance, trade-off and pecking order theories. CONCLUSION : The findings link theories of the severity of distress, reasonable prospect and capital structure in an alternative way and provide a framework for capital structure decision-making in financially distressed companies. This research aims to stimulate further academic research and to have practical applications. CONTRIBUTION : For the first time, this study by using Q-methodology explored different stakeholder perspectives and proposed expanded frameworks for determining the severity of distress and the prospects for rescue. It adapted existing frameworks to be less subjective and more aligned with practical capital structure decisions.