Liquidation – Definition

Cite this article as:"Liquidation – Definition," in The Business Professor, updated March 25, 2019, last accessed September 23, 2020, https://thebusinessprofessor.com/lesson/liquidation-event-definition/.

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Liquidation Definition

Liquidation basically refers to the practice of selling off a company’s inventory, or property so that it can get money in return. Mostly, liquidation leads to closure of a business to sell its all stock and other tangible properties. Once all the assets have been sold, the business is shut down.  After the company sells its properties, it uses the money to pay off creditors, or anyone the company owes money to. Selling of these company’s properties is taken through by the company’s different investors who have their shares in the company or court ruling granting creditors consent to go ahead for liquidation. This happens after a company closes and the assets are sold. After selling the properties, the earnings are then used to pay banks and other lenders that may lend the company money or maybe have provided goods or services to the company and were to be paid at a later date.   The money that remains after the payment of creditors is shared to the companies or individuals who have shares in the company.

A Little More on What is Liquidation

The liquidation procedure entails;

  • ¬†¬†¬†¬†¬†¬†¬†¬†Assets are turned into liquid cash. This may be realized by disposing the whole subsidiary to a different company. The same may apply when an investor disposes of certain collateral.
  • ¬†¬†¬†¬†¬†¬†¬†¬†Settling of debt obligation.
  • ¬†¬†¬†¬†¬†¬†¬†¬†Disposing assets to pay debts when the firm predicts quitting the business.

Liquidation value refers to price in which a company would sell its properties at a rush due to the need to settle its liabilities. This idea is mostly used in firms that are considered likely to have financial issues or maybe the company is falling. Company‚Äôs properties can be depreciated over time to reduce the recorded cost of the asset. Most of these assets include machinery, buildings, and equipment. Company‚Äôs money and any other properties that are elusive are not sold out since they have no depreciating value. Cash liquidation distribution refers to the return of remaining money of business to investors after a company’s properties have been sold out. The extra money and the money from the assets sold out are then distributed to the appropriate parties according to the company‚Äôs financial plan.

Liquidation may also be as a result of the closure of a business venture.  This basically happens when a certain shareholder in a company wants to sell its property/shares to get money instead. This cans also occur in a situation like if a shareholder wants to switch positions in a company in terms of their investments size and profits.  For example, if a shareholder has big shares in the company, he/she can then have the same number of small shares. When the company decides to sell its properties, then all the activities in the company stops and all the properties are counted and shared out to the different claimant.  The guarantor then owns the company and takes over. Anyone owing the company any money is not paid since the paying process never takes place and no one actually is there to pay them. So they just find a way to cancel out the debts.

References for Liquidation

Academic Research on Liquidation

Liquidation values and debt capacity: A market equilibrium approach, Shleifer, A., & Vishny, R. W. (1992). The Journal of Finance, 47(4), 1343-1366. ¬†The price at which the company sells its properties during liquidation is determined by the prospective buyers. During this time of financial challenges in a company or when a company is considered to be falling and running out of finances, the managers and the employer are also likely to undergo pressure and stress too resulting to the sale of company’s properties at prices below the market price. ¬†Due to this price variation of assets especially resulting in sale of the properties at a very low cost due to rush, companies tend to sell the assets by comparing the original value and the current market price to sell the assets at a better price. This also determines the company debts across different firms and over the company set.

The effect of capital structure on a firm’s liquidation decision, Titman, S. (1984). Journal of financial economics, 13(1), 137-151. Liquidating a company may come along with different impacts on its suppliers, customers and also workers. ¬†Therefore, the company relationship with the customers, suppliers and the workers is greatly affected. If the company decides to close down and sell its assets, then the employers lose their jobs, the suppliers lose their markets while the customers have to start looking for an alternative place where they can get the same services or buy other goods. Some workers who were unpaid need to be paid and the suppliers who had to lend the company goods also need to be settled their debts. Money can, therefore, be used to settle down all the misunderstandings that can be caused by such a company’s decisions. Suitable money plan makes it possible for the gearing in of the previous money values of the assets before the liquidation, to make sure that the company doesn’t go great loses in the process.

Liquidation costs and capital structure, Alderson, M. J., & Betker, B. L. (1995). Journal of Financial Economics, 39(1), 45-69. ¬†The comparison between the making of money structure in a company and selling of the company’s property is looked into and was recognized under chapter 11 of the Insolvency code. Companies with low arrears ratio were under Chapter 11 since it had a relative more Insolvency rate. Such companies highly expected to hoist new compensation money, and their debts are mostly municipal and unrestricted. ¬†These firms also have less restraining agreements. Properties that have assets that are sold at a higher price results in firms going for money plans that prevent financial stress.

The costs of bankruptcy: Chapter 7 liquidation versus Chapter 11 reorganization, Bris, A., Welch, I., & Zhu, N. (2006). The journal of finance, 61(3), 1253-1303. This paper studies two companies which are from Arizona and New York and their liquidation costs are contrasted. These two companies are in different sizes. Liquidation costs are very diverse and responsive to the methods of study used. Chapter 11 involves restricting its debts and rehabilitating the bankruptcy firm. The business is no longer in existence once the selling of assets is complete. Therefore, it is friendlier and serves better.  In Chapter 7 liquidation, the business debts still exist. The debt will remain until the bill of limitation has elapsed and since there is no debtor owed anymore; the creditor then writes off the debt.

Value under liquidation, Almgren, R., & Chriss, N. (1999). Risk, 12(12), 61-63. This article is concerned with highlighting the value that arises as a result of the liquidation.

The liquidation of government debt, Reinhart, C. M., & Sbrancia, M. B. (2011). (No. w16893). National Bureau of Economic Research. Firms that are owed by the public usually come up with a lot of issues during the liquidation of the company and settling down of the debts. Debts are also reduced by recouping the balance from the company’s remaining liquid assets if any. This includes the government (if it owed taxes) and the employees (if they are owed unpaid wages or other obligations). ¬†Money repressions best work in settling debts especially when they are followed by raised prices. In developed countries, interest duty was negative half of the time in the years of 1945 -1980. During these years‚Äô normal yearly tax rate for a 12- country section varied from 1 to 5 percent net domestic profits for the whole duration (1945-1980). Therefore, money repression may be used in the handling of public debts in such economies.

Risk aversion and the dynamics of optimal liquidation strategies in illiquid markets, Schied, A., & Schöneborn, T. (2009). Finance and Stochastics, 13(2), 181-204.  In this paper we also consider infinite-horizon most favorable case of liquidation issues for a von Neumann- Morgenstern investor in the liquidity form of Almgren. By use of stochastic control method, we put the price function and the optimal strategy as a standard problem solver of nonlinear parabolic partial differential equations.  We also analyze the response of the value function and the optimal strategy relative to different replica parameters. The optimal strategy is, therefore, more beneficial in liquidation only when the utility function lowers or raises the risk aversion. In summary, the rate in which the properties that were left unsold can be declining in range of location but rising in the cost impact.

Hedging and liquidation under transaction costs in currency markets, Kabanov, Y. M. (1999). Finance and Stochastics, 3(2), 237-248. Self-financing portfolio helps in determining overall semi martingale methodology of money market with operation prices and gives an explanation of the previous endowments which help in evading subject asserts in different currencies. Through this plan of most favorable methodologies for the issues of raising expected value from lethal wealth is obtained.

Do liquidation values affect financial contracts? Evidence from commercial loan contracts and zoning regulation, Benmelech, E., Garmaise, M. J., & Moskowitz, T. J. (2005). The Quarterly Journal of Economics, 120(3), 1121-1154.  In this paper we find out the effects of property selling cost in relation to debt payment through commercial asset non-resource loan contracts. Business allocation regulation is used to liberate the change in assets allowed uses as a tool of property re-usage or cost in its subsequent top use.  Most reusable properties get bigger loans with higher maturities and periods, low tax rates, fewer creditors, its deviation in value, type and locality. These findings are steady with partial contracting and operation prices theories of liquidation value and money plan.

Economic distress, financial distress, and dynamic liquidation, Kahl, M. (2002). The Journal of Finance, 57(1), 135-168. This article stresses on lack of enough information on liquidation decisions affects creditors largely. ¬†Companies developing from debt reformation stay with money issues, don’t invest more and doesn’t perform well. All these issues come from poor management by the creditors and poor plan of liquidation laws. It also talks more on money issue which is as a result of lack of information from the creditors on the investment and money problem-solving issues left unsettled for long.

Liquidation values and the credibility of financial contract renegotiation: Evidence from US airlines, Benmelech, E., & Bergman, N. K. (2008). The Quarterly Journal of Economics, 123(4), 1635-1677. [Re-written] This paper attempts to explain the relation of liquidation cost and money deal renegotiation. There are contradicting theories on that liquidation cost affects the placing of bargaining power between the debtors and creditors. There is also practical proof on money contract renegotiation and the faction property cost in bargaining. Airline company in the United States is used in coming up with the money agreement renegotiation and it’s approximated using data. Airlines fruitfully renegotiate on their charter issues downwards when their financial status is unstable and when their fleet liquidation cost is low.

Trade credit, collateral liquidation, and borrowing constraints, Fabbri, D., & Menichini, A. M. C. (2010). Journal of Financial Economics, 96(3), 413-432. Assumptions made on the company’s suppliers can well get profits from liquidation since they are better informed on the cost of the asset than the creditors. This article comes up with six predictions from the usage of trade recognition. 1)Trade credit is lowered by improved creditor security. 2) Suppliers loan their clients goods but not money. 3) High usage of goods is related to higher dependence on trade credit. 4) Companies with free bank credit lines make use of the supplier’s liquidation benefit. 5) Companies buying services make fewer orders from suppliers compare to those purchasing tangible goods, therefore suppliers of services give more trade credit than those of physical goods. 6) ¬†Credit rationing does not vary due to the dependence of trade credits if goods ordered on the account are adequately liquid.

Investment and liquidation in renegotiation-proof contracts with moral hazard, Quadrini, V. (2004). Journal of Monetary Economics, 51(4), 713-751. According to contracts with moral hazard, the liquidation of the company can increase as a result of the best contract. Nevertheless, if the coming market opportunities or manufacturing potentiality stays constant, then renegotiation on liquidation assets remains. The company can also face liquidation even though renegotiation is still allowed in the long term agreement. The renegotiation-proof agreement results in beneficial features of business venture discipline and dynamics of companies as seen in the data.

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