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Health Care Organizations and bankruptcy

The following discussion leads to 3 questions below, each requiring no more than a 50-100 word response. Use the attached material to help answer the questions.

Many believe that modern capital structure theory began when Professors Modigliani and Miller (better known as the first M&M) published their 1958 paper, "The Cost of Capital, Corporation Finance and the Theory of Investment." In their paper, M&M showed, under a very restrictive set of assumptions, that a firm's value is unaffected by its capital structure. In other words, M&M suggested that it does not matter how a firm finances its operations, hence capital structure is irrelevant.

Their initial paper had a number of critics, especially since the study was based on some rather unrealistic assumptions. Nevertheless, M&M's irrelevance result is very important to the theory of corporate finance. By indicating the conditions under which capital structure is irrelevant, M&M also provides readers with clues about what is required for capital structure to be relevant and hence to affect a firm's value.

M&M published several more studies which expanded the concepts in their 1958 article, and directly addressed critics' comments. The resulting "M&M Theorems" on capital structure and dividend policy are an essential element of the foundations of the theory of corporate finance. M&M's efforts in this area were among the achievements which resulted in a Nobel Prize for both authors in 1990.

McLean does a pretty good job of reviewing M&M's work (starting on page 254). It is noted that M&M's irrelevance results depend on the assumption that firms do not go bankrupt; hence there are no bankruptcy costs. However, in practice bankruptcy exists, and it can be quite costly, as shown in McLean. Note, too, that the threat of bankruptcy also brings about multiple problems for the firm.

Recent OIG reports ( show that financial distress is the top reason for hospital closures in the US. Since bankruptcy is an available option for dealing with financial distress I would like to get your views on this issue.


1. What does a bankruptcy actually do for a HCO? Include a discussion of the types of bankruptcy available to HCOs in your response. How does the threat of bankruptcy affect the HCO?

2. What options, other than bankruptcy, are available to the HCO suffering from severe financial distress?

3. Do you see any trends in HCO bankruptcy? Can you provide an example of a HCO which used bankruptcy to deal with financial problems?

Please be concise, no more than 50-100 words for each question. Thank you.


Solution Preview

Please see response attached (Posting 77171.doc) (some of which is presented below), including one supporting article. .


1. What does a bankruptcy actually do for a HCO? Include a discussion of the types of bankruptcy available to HCOs in your response. How does the threat of bankruptcy affect the HCO?

There are two forms of bankruptcy available. (1) A proceeding in a federal court in which an insolvent debtor's assets are liquidated and the debtor is relieved of further liability. Chapter 7 of the Bankruptcy Reform Act deals with liquidation, while (2) Chapter 11 deals with reorganization. The risk of threat increases WACC, and the Health Care Organization (HCO) has less internal cash flow available for programs, maintenance, administration and operations necessary to provide quality care and the HCOs overall objectives. Thus, it ...

Solution Summary

By responding to the questions, this solution addresses topics related to Health Care Organizations and bankruptcy. Supplemented with an article related to the topic.