This section is from the book "Business Finance", by William Henry Lough. Also available from Amazon: Business Finance, A Practical Study of Financial Management in Private Business Concerns.
One customary result of reorganization is an increase in capitalization. At first glance this may seem surprising, but it is the necessary result of the policy of compensating the old security holders for their sacrifices by giving them some form of claim on the future earnings of the corporation. Junior bondholders are usually asked to accept a percentage of new bonds plus a percentage of preferred shares, the new securities having a total nominal value at least equivalent to the nominal value of the bonds they formerly held. The preferred shareholder is perhaps asked to pay an assessment and accept new securities consisting of preferred and common shares. The common shares may be reduced or wiped out, but more often, upon payment of assessment, are replaced by shares of not greatly reduced nominal value. In general, the tendency is strongly toward reducing bond capitalization and increasing the share capitalization more than proportionately.
Another customary result in large corporations is the simplification of the company's financial structure. In the years preceding reorganization the company has in all probability put out various issues of bonds, preferred shares, and common shares, some of which may have conflicting or uncertain claims. Reorganization gives an opportunity to replace these various small issues by a few large issues. At the same time, increased facilities for raising capital in future are often provided. The new issues are made large enough to provide for the immediate needs of the reorganized company, with the proviso that additional bonds may be sold under the same mortgage on fulfillment of the conditions, set forth in the deed of trust. Through this simplification and provision for future capital requirements the company's financial structure may be brought into line with the best present-day practice. This is often one great advantage of reorganization.
Another advantage frequently afforded by a reorganization is the opportunity to eliminate unprofitable branches or departments. Sometimes the bondholders who are secured by a mortgage or a branch or an isolated plant are bluntly told that they may take the property which is not wanted by the parent corporation. More often, the fact that the property to which they have a claim is not essential, is driven home and they are forced to agree to a considerable reduction in their claims, which may be sufficient to put the outlying branch or plant on a profitable basis. Reorganization is apt to be carried on in a cold-blooded way by financial men who are impressed only by results that have actually been achieved. Frequently the main difficulty with a business that has become insolvent has been overoptimism and overexpansion on the part of its management. Wherever that is the case, a reorganization which eliminates these outside ventures or reduces the expense of conducting them may prove of great and lasting benefit to the corporation.