Debt valuation with endogenous default and Chapter 11 reorganization

Persistent Link:
http://hdl.handle.net/10150/280321
Title:
Debt valuation with endogenous default and Chapter 11 reorganization
Author:
Paseka, Alexander I.
Issue Date:
2003
Publisher:
The University of Arizona.
Rights:
Copyright © is held by the author. Digital access to this material is made possible by the University Libraries, University of Arizona. Further transmission, reproduction or presentation (such as public display or performance) of protected items is prohibited except with permission of the author.
Abstract:
We examine a continuous-time structural model of debt valuation with the possibility of default and Chapter 11 bankruptcy. In doing so, we derive Chapter 11 duration and allocations to the debtor and bondholders in Chapter 1 I as the outcomes of a bargaining game between the debtor and the bondholders. The absolute priority rule (APR) violations arising in equilibrium are then embedded into closed-form solutions for the values of equity, finite-maturity debt, and credit spreads. It has been recently documented that existing credit risk models explain only a fraction of the observed yield spreads when confronted with the data on default rate and recovery rate at default (e.g., Collin-Dufresne et al. (2001) and Elton et al. (2001)). Taking the exclusivity period as an approximation to a legal environment of the bargaining process, we model Chapter 11 as the debtor's ultimatum offers to the bondholders and calibrate the model using an approach similar to that of Huang and Huang (2002). We obtain credit spreads that are twice to three times as large as those produced by the model in Leland and Toft (1996). The reason why this result holds in our model is that when the debtor obtains a non-zero allocation in bankruptcy, her option to default is worth more and exercised sooner than in Leland and Toft's model. Therefore, the debt value is smaller, and consequently, credit spreads are higher. Calibrated credit spreads are high for firms expected to be more solvent at default and those with large absolute priority rule violations. Finally, our model predicts a significant cross-sectional variation in Chapter 11 duration. Indeed, such heterogeneity is seen in actual bankruptcy experiences. We discuss several new empirical implications of the model with regards to the expected time in bankruptcy as a function of different firm characteristics. The model predicts that firms with a higher fraction of intangible assets, lower pre-bankruptcy volatility of asset value, and lower average maturity of debt in their capital structure spend less time in Chapter 11.
Type:
text; Dissertation-Reproduction (electronic)
Keywords:
Economics, Finance.
Degree Name:
Ph.D.
Degree Level:
doctoral
Degree Program:
Graduate College; Business Administration
Degree Grantor:
University of Arizona
Advisor:
Lamoureux, Chris

Full metadata record

DC FieldValue Language
dc.language.isoen_USen_US
dc.titleDebt valuation with endogenous default and Chapter 11 reorganizationen_US
dc.creatorPaseka, Alexander I.en_US
dc.contributor.authorPaseka, Alexander I.en_US
dc.date.issued2003en_US
dc.publisherThe University of Arizona.en_US
dc.rightsCopyright © is held by the author. Digital access to this material is made possible by the University Libraries, University of Arizona. Further transmission, reproduction or presentation (such as public display or performance) of protected items is prohibited except with permission of the author.en_US
dc.description.abstractWe examine a continuous-time structural model of debt valuation with the possibility of default and Chapter 11 bankruptcy. In doing so, we derive Chapter 11 duration and allocations to the debtor and bondholders in Chapter 1 I as the outcomes of a bargaining game between the debtor and the bondholders. The absolute priority rule (APR) violations arising in equilibrium are then embedded into closed-form solutions for the values of equity, finite-maturity debt, and credit spreads. It has been recently documented that existing credit risk models explain only a fraction of the observed yield spreads when confronted with the data on default rate and recovery rate at default (e.g., Collin-Dufresne et al. (2001) and Elton et al. (2001)). Taking the exclusivity period as an approximation to a legal environment of the bargaining process, we model Chapter 11 as the debtor's ultimatum offers to the bondholders and calibrate the model using an approach similar to that of Huang and Huang (2002). We obtain credit spreads that are twice to three times as large as those produced by the model in Leland and Toft (1996). The reason why this result holds in our model is that when the debtor obtains a non-zero allocation in bankruptcy, her option to default is worth more and exercised sooner than in Leland and Toft's model. Therefore, the debt value is smaller, and consequently, credit spreads are higher. Calibrated credit spreads are high for firms expected to be more solvent at default and those with large absolute priority rule violations. Finally, our model predicts a significant cross-sectional variation in Chapter 11 duration. Indeed, such heterogeneity is seen in actual bankruptcy experiences. We discuss several new empirical implications of the model with regards to the expected time in bankruptcy as a function of different firm characteristics. The model predicts that firms with a higher fraction of intangible assets, lower pre-bankruptcy volatility of asset value, and lower average maturity of debt in their capital structure spend less time in Chapter 11.en_US
dc.typetexten_US
dc.typeDissertation-Reproduction (electronic)en_US
dc.subjectEconomics, Finance.en_US
thesis.degree.namePh.D.en_US
thesis.degree.leveldoctoralen_US
thesis.degree.disciplineGraduate Collegeen_US
thesis.degree.disciplineBusiness Administrationen_US
thesis.degree.grantorUniversity of Arizonaen_US
dc.contributor.advisorLamoureux, Chrisen_US
dc.identifier.proquest3090009en_US
dc.identifier.bibrecord.b44425752en_US
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