A recent article in The Wall Street Journal (October 2, 1990) noted that as the country slid deeper into a recession in the early 1990s, companies with high amounts of cash relative to their debt are likely to be coveted by the stock market, while companies with high levels of debt will be slashing dividends, payrolls, and capital expenditures to stay afloat. High debt, combined with slower sales and increasing energy and labor costs, will prove to be a deadly combination for a number of companies, and Standard and Poor’s found that both dividend decreases and omissions were up in 1990. The Wall Street Journal reported the following year that defaults on corporate notes and bonds payable rose to a record level as companies missed payments of $8.2 billion of debt. Moody’s Investor Service notes further that in the past 15 years an average of only 41 percent of the face value of defaulted debt was recovered by investors; secured bondholders recovered an average of 67 percent of the face value, while holders of debentures recovered an average of only 23 percent. REQUIRED:

a. U.S. corporations have dramatically increased their debt levels since 1980. Discuss how high levels of debt may influence the way in which a company is managed. That is, how might management concerns and decisions be different because a company is carrying a large amount of debt?

b. Describe the financial statement effects of this borrowing activity, and explain how these effects could have helped investors and creditors to avoid the losses incurred during the recession in the early 1990s. How and why might the reported levels of debt on the bal¬ ance sheet be less than the actual levels of debt carried by the company?

c. Define a debenture and explain why defaults on debentures would lead to a lower recov¬ ery rate for investors than defaults on secured bonds