We explore the idea that financial distress is costly because free-rider problems and information asymmetries make it difficult for firms to renegotiate with their creditors. We present evidence that Japanese firms with financial structures in which these problems are likely to be small perform better than other firms after the onset of distress. In particular, we show that firms in industrial groups — those with close financial relationships to their banks, suppliers, and customers — invest more and sell more after the onset of distress than nongroup firms. We find similar results for nongroup firms that nevertheless have strong ties to a main bank.