Bankruptcy costs and their effect on The value of the firm: the case of the Banking institutions in Kenya

Abstract

The banking industry plays a major role in the economic development as they provide the money to be invested, by matching the needs of depositors who have excess money in their hands and the borrowers who have less money at their disposal. There is need to understand the implications of banks being placed under statutory management. The study'stwo objectives assessed the costs of bankruptcy as a percentage of the value of the banks. The study sought to determine the relationship that exists between the costs of bankruptcy and the value of the bank. A sample of eight banks was drawn based on the data availed by the Central Bank of Kenya for banks that failed between 1998 and 2002. The data of the operational banks between 1996 and 2002 was used to develop the regression equation. The findings were as follows:- 1. The costs of bankruptcy as a percentage of the value of the bank was significant for the period of the study. The total costs of bankruptcy as a percentage of the total assets of the bank was above a hundred percent in the year of failure. This implies that bankruptcy costs are significant in the decline of the value of the bank when it is placed under statutory management. There is need for stakeholders to determine the probability of financiai distress and! or bankruptcy when making financing and investment decisions to ensure the maximization of shareholders wealth. II 2. The bankruptcy costs were noted to increase as the date of bankruptcy approached. The bankruptcy costs may be reduced if the Central Bank of Kenya takes prompt action to place all banks under statutory management when they begin to show signs that the bank may experience financial distress. The bank may then reorganize its operations and continue with the banking business. 3. The bankruptcy costs increased as failure approached for each of the three categories as defined according to size. The bankruptcy costs were higher for the larger banks as opposed to the smaller banks, as a percentage of the total assets. The mean of the large banks is significantly different from that of the medium banks and the small banks. This can be explained by the fact that the large banks have clientele who may have ready access to public as well as private information on the banks performance and they will act on the information promptly which makes the bankruptcy costs to be high. The clientele of the small banks are likely to be small depositors who may not have ready access to information on the banks performance and the large amounts of cash required to open an account will shut them out of the large banks. This type of depositors may react slowly to the information about the banks impending bankruptcy. The medium banks will have depositors who are a cross between those of the large and small banks. On the basis of these findings, it is recommended that bankruptcy costs be considered when making decisions as relates to financing and investment decisions, especially if the bank is larger as the costs are higher.