Page 77 - Bankruptcy and Reorganization Services

rupt companies because employees are more likely to leave the company in favor of a more financially
stable employer.

Unsystematic Risk. Although the types of company-specific risk are almost endless, it is helpful to con-
centrate on the common examples. The following are some of the more frequently encountered compa-
ny-specific risks. These risk factors are often interrelated.

 Small company (size)

 Key person dependence

 Key supplier dependence

 Forecast uncertainty (achievability)

 Customer concentration

 Litigation

 Forecast bias

Each of these risk factors can be exacerbated by financial distress. Small companies have fewer re-
sources to deal with distress and often have limited access to capital. Key executives may leave or be
terminated. Key suppliers will often place restrictions on shipments, and key customers may take their
business to competitors. Forecast uncertainty and litigation risks both increase dramatically. Companies
in financial distress are also generally less equipped to deal with risk factors because they have scarcer
resources than healthy companies. Accordingly, the alpha factor can become a much more significant
component of the calculation and have a greater influence on the results.

Forecast bias is an additional company-specific risk, which can increase for a financially troubled firm.
Forecast bias is different from forecast error. Forecast error is the uncertainty inherent in financial pro-
jections. Forecast bias occurs when forecasts are overly optimistic or overly pessimistic due to the moti-
vations of the preparers of the projections — typically management. Motivations may include a desire to
keep the business out of liquidation or set baseline expectations at a level that will be easy to meet or ex-
ceed. The analyst must be especially diligent in challenging management’s assertions when reviewing
the projections of distressed companies.

Finally, the practitioner should be aware that, in certain circumstances, company-specific factors can
help mitigate the overall risk profile of a company. Examples may include companies with well-known
brand names, unique products, a strong product pipeline, and so on. Incorporating this kind of infor-
mation into a bankruptcy valuation engagement requires a substantial amount of professional judgment.
Therefore, practitioners must employ a heightened sense of critical thinking to help ensure these inputs
withstand scrutiny from the users of the information.

Restructuring Risk. This risk premium accounts for the uncertainty involved in the ability of a company
in bankruptcy to sufficiently restructure its capital structure as well as human capital (the workforce).
There are two types of restructuring risks: financial restructuring risk and operational restructuring risk.

Financial restructuring risk is the risk that the capital structure of the business cannot be successfully re-
organized (or delevered) so that the company can service its debt from ongoing operations. Financial re-

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