IDEAS home Printed from https://ideas.repec.org/a/eee/jfinec/v142y2021i3p1092-1108.html
   My bibliography  Save this article

The bank as Grim Reaper: Debt composition and bankruptcy thresholds

Author

Listed:
  • Carey, Mark
  • Gordy, Michael B.

Abstract

We offer a model and evidence showing that private debtholders play a key role in setting the endogenous asset value threshold below which corporations declare bankruptcy. As predicted by the model, we find that the recovery rate at emergence from bankruptcy on all of the firm’s debt taken together is increasing in the pre-bankruptcy share of private debt in all debt. We further find evidence consistent with a two-threshold model in which private debtholders force default in some cases and shareholders default strategically in others.

Suggested Citation

  • Carey, Mark & Gordy, Michael B., 2021. "The bank as Grim Reaper: Debt composition and bankruptcy thresholds," Journal of Financial Economics, Elsevier, vol. 142(3), pages 1092-1108.
    • Handle: RePEc:eee:jfinec:v:142:y:2021:i:3:p:1092-1108
    DOI: 10.1016/j.jfineco.2021.05.048
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S0304405X21002415
    Download Restriction: Full text for ScienceDirect subscribers only
    File URL: https://libkey.io/10.1016/j.jfineco.2021.05.048?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to look for a different version below or search for a different version of it.

    Other versions of this item:

    References listed on IDEAS

    as
    1. Black, Fischer & Cox, John C, 1976. "Valuing Corporate Securities: Some Effects of Bond Indenture Provisions," Journal of Finance, American Finance Association, vol. 31(2), pages 351-367, May.
    2. Bourgeon, Jean-Marc & Dionne, Georges, 2013. "On debt service and renegotiation when debt-holders are more strategic," Journal of Financial Intermediation, Elsevier, vol. 22(3), pages 353-372.
    3. Berlin, Mitchell & Nini, Greg & Yu, Edison G., 2020. "Concentration of control rights in leveraged loan syndicates," Journal of Financial Economics, Elsevier, vol. 137(1), pages 249-271.
    4. Duffie, Darrell & Lando, David, 2001. "Term Structures of Credit Spreads with Incomplete Accounting Information," Econometrica, Econometric Society, vol. 69(3), pages 633-664, May.
    5. Michael Faulkender & Mitchell A. Petersen, 2006. "Does the Source of Capital Affect Capital Structure?," The Review of Financial Studies, Society for Financial Studies, vol. 19(1), pages 45-79.
    6. Mella-Barral, Pierre & Perraudin, William, 1997. "Strategic Debt Service," Journal of Finance, American Finance Association, vol. 52(2), pages 531-556, June.
    7. Leland, Hayne E, 1994. "Corporate Debt Value, Bond Covenants, and Optimal Capital Structure," Journal of Finance, American Finance Association, vol. 49(4), pages 1213-1252, September.
    8. Cheol Park, 2000. "Monitoring and Structure of Debt Contracts," Journal of Finance, American Finance Association, vol. 55(5), pages 2157-2195, October.
    9. Acharya, Viral V. & Bharath, Sreedhar T. & Srinivasan, Anand, 2007. "Does industry-wide distress affect defaulted firms? Evidence from creditor recoveries," Journal of Financial Economics, Elsevier, vol. 85(3), pages 787-821, September.
    10. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-470, May.
    11. Nicolae Garleanu & Jeffrey Zwiebel, 2009. "Design and Renegotiation of Debt Covenants," The Review of Financial Studies, Society for Financial Studies, vol. 22(2), pages 749-781, February.
    12. Leland, Hayne E & Toft, Klaus Bjerre, 1996. "Optimal Capital Structure, Endogenous Bankruptcy, and the Term Structure of Credit Spreads," Journal of Finance, American Finance Association, vol. 51(3), pages 987-1019, July.
    13. Longstaff, Francis A & Schwartz, Eduardo S, 1995. "A Simple Approach to Valuing Risky Fixed and Floating Rate Debt," Journal of Finance, American Finance Association, vol. 50(3), pages 789-819, July.
    14. Dirk Hackbarth & Christopher A. Hennessy & Hayne E. Leland, 2007. "Can the Trade-off Theory Explain Debt Structure?," The Review of Financial Studies, Society for Financial Studies, vol. 20(5), pages 1389-1428, 2007 04.
    15. Sudheer Chava & Michael R. Roberts, 2008. "How Does Financing Impact Investment? The Role of Debt Covenants," Journal of Finance, American Finance Association, vol. 63(5), pages 2085-2121, October.
    16. Mark Broadie & Mikhail Chernov & Suresh Sundaresan, 2007. "Optimal Debt and Equity Values in the Presence of Chapter 7 and Chapter 11," Journal of Finance, American Finance Association, vol. 62(3), pages 1341-1377, June.
    17. Sudheer Chava & Praveen Kumar & Arthur Warga, 2010. "Managerial Agency and Bond Covenants," The Review of Financial Studies, Society for Financial Studies, vol. 23(3), pages 1120-1148, March.
    18. Fan, Hua & Sundaresan, Suresh M, 2000. "Debt Valuation, Renegotiation, and Optimal Dividend Policy," The Review of Financial Studies, Society for Financial Studies, vol. 13(4), pages 1057-1099.
    19. Michael Schwert, 2020. "Does Borrowing from Banks Cost More than Borrowing from the Market?," Journal of Finance, American Finance Association, vol. 75(2), pages 905-947, April.
    20. White, Halbert, 1980. "A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity," Econometrica, Econometric Society, vol. 48(4), pages 817-838, May.
    21. Sergei A. Davydenko & Ilya A. Strebulaev & Xiaofei Zhao, 2012. "A Market-Based Study of the Cost of Default," The Review of Financial Studies, Society for Financial Studies, vol. 25(10), pages 2959-2999.
    22. Ilia D. Dichev & Douglas J. Skinner, 2002. "Large–Sample Evidence on the Debt Covenant Hypothesis," Journal of Accounting Research, Wiley Blackwell, vol. 40(4), pages 1091-1123, September.
    23. Edward I. Altman & Brooks Brady & Andrea Resti & Andrea Sironi, 2005. "The Link between Default and Recovery Rates: Theory, Empirical Evidence, and Implications," The Journal of Business, University of Chicago Press, vol. 78(6), pages 2203-2228, November.
    24. Michael R. Roberts & Amir Sufi, 2009. "Control Rights and Capital Structure: An Empirical Investigation," Journal of Finance, American Finance Association, vol. 64(4), pages 1657-1695, August.
    25. Amir Sufi, 2009. "Bank Lines of Credit in Corporate Finance: An Empirical Analysis," The Review of Financial Studies, Society for Financial Studies, vol. 22(3), pages 1057-1088, March.
    26. Amir Sufi, 2009. "Bank Lines of Credit in Corporate Finance: An Empirical Analysis," The Review of Financial Studies, Society for Financial Studies, vol. 22(3), pages 1057-1088.
    27. Greg Nini & David C. Smith & Amir Sufi, 2012. "Creditor Control Rights, Corporate Governance, and Firm Value," The Review of Financial Studies, Society for Financial Studies, vol. 25(6), pages 1713-1761.
    28. Mella-Barral, Pierre, 1999. "The Dynamics of Default and Debt Reorganization," The Review of Financial Studies, Society for Financial Studies, vol. 12(3), pages 535-578.
    29. Zhang, Zhipeng, 2009. "Who Pulls the Plug? Theory and Evidence on Corporate Bankruptcy Decisions," MPRA Paper 17676, University Library of Munich, Germany, revised 05 Oct 2009.
    30. Gilson, Stuart C. & John, Kose & Lang, Larry H. P., 1990. "Troubled debt restructurings*1: An empirical study of private reorganization of firms in default," Journal of Financial Economics, Elsevier, vol. 27(2), pages 315-353, October.
    31. Bharath, Sreedhar T. & Panchapegesan, Venky & Werner, Ingrid, 2007. "The Changing Nature of Chapter 11," Working Paper Series 2008-4, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
    32. Jon Frye, 2000. "Depressing recoveries," Emerging Issues, Federal Reserve Bank of Chicago, issue Oct.
    33. Ronn, Ehud I & Verma, Avinash K, 1986. "Pricing Risk-Adjusted Deposit Insurance: An Option-Based Model," Journal of Finance, American Finance Association, vol. 41(4), pages 871-895, September.
    34. Zhou, Chunsheng, 2001. "The term structure of credit spreads with jump risk," Journal of Banking & Finance, Elsevier, vol. 25(11), pages 2015-2040, November.
    35. Nash, Robert C. & Netter, Jeffry M. & Poulsen, Annette B., 2003. "Determinants of contractual relations between shareholders and bondholders: investment opportunities and restrictive covenants," Journal of Corporate Finance, Elsevier, vol. 9(2), pages 201-232, March.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Demirgüç-Kunt, Asli & Horváth, Bálint & Huizinga, Harry, 2023. "Loan recoveries and the financing of zombie firms over the business cycle," CEPR Discussion Papers 18351, C.E.P.R. Discussion Papers.
    2. Sharjil M. Haque & Anya V. Kleymenova, 2023. "Private Equity and Debt Contract Enforcement: Evidence from Covenant Violations," Finance and Economics Discussion Series 2023-018, Board of Governors of the Federal Reserve System (U.S.).
    3. Frame, W. Scott & Lazaryan, Nika & McLemore, Ping & Mihov, Atanas, 2024. "Operational loss recoveries and the macroeconomic environment: Evidence from the U.S. banking sector," Journal of Banking & Finance, Elsevier, vol. 165(C).
    4. Michael Schwert, 2020. "Does Borrowing from Banks Cost More than Borrowing from the Market?," Journal of Finance, American Finance Association, vol. 75(2), pages 905-947, April.
    5. Song Ma & Joy Tianjiao Tong & Wei Wang, 2022. "Bankrupt Innovative Firms," Management Science, INFORMS, vol. 68(9), pages 6971-6992, September.
    6. Berlin, Mitchell & Nini, Greg & Yu, Edison G., 2020. "Concentration of control rights in leveraged loan syndicates," Journal of Financial Economics, Elsevier, vol. 137(1), pages 249-271.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Marc Arnold & Ramona Westermann, 2023. "Debt Renegotiations Outside Distress," Review of Finance, European Finance Association, vol. 27(4), pages 1183-1228.
    2. Dionne, Georges & Laajimi, Sadok, 2012. "On the determinants of the implied default barrier," Journal of Empirical Finance, Elsevier, vol. 19(3), pages 395-408.
    3. Abel Elizalde, 2006. "Credit Risk Models II: Structural Models," Working Papers wp2006_0606, CEMFI.
    4. François, Pascal & Naqvi, Hassan, 2023. "Secured and unsecured debt in creditor-friendly bankruptcy," Journal of Corporate Finance, Elsevier, vol. 80(C).
    5. Zhang, Zhipeng, 2009. "Who Pulls the Plug? Theory and Evidence on Corporate Bankruptcy Decisions," MPRA Paper 17676, University Library of Munich, Germany, revised 05 Oct 2009.
    6. Jean-David Fermanian, 2020. "On the Dependence between Default Risk and Recovery Rates in Structural Models," Annals of Economics and Statistics, GENES, issue 140, pages 45-82.
    7. Gryglewicz, Sebastian, 2011. "A theory of corporate financial decisions with liquidity and solvency concerns," Journal of Financial Economics, Elsevier, vol. 99(2), pages 365-384, February.
    8. Christensen, Peter Ove & Flor, Christian Riis & Lando, David & Miltersen, Kristian R., 2014. "Dynamic capital structure with callable debt and debt renegotiations," Journal of Corporate Finance, Elsevier, vol. 29(C), pages 644-661.
    9. Berlin, Mitchell & Nini, Greg & Yu, Edison G., 2020. "Concentration of control rights in leveraged loan syndicates," Journal of Financial Economics, Elsevier, vol. 137(1), pages 249-271.
    10. Duffie, Darrell, 2005. "Credit risk modeling with affine processes," Journal of Banking & Finance, Elsevier, vol. 29(11), pages 2751-2802, November.
    11. Han, Bing & Zhou, Yi, 2015. "Understanding the term structure of credit default swap spreads," Journal of Empirical Finance, Elsevier, vol. 31(C), pages 18-35.
    12. Ayadi, Mohamed A. & Ben-Ameur, Hatem & Fakhfakh, Tarek, 2016. "A dynamic program for valuing corporate securities," European Journal of Operational Research, Elsevier, vol. 249(2), pages 751-770.
    13. Correia, Ricardo & Población, Javier, 2015. "A structural model with Explicit Distress," Journal of Banking & Finance, Elsevier, vol. 58(C), pages 112-130.
    14. Duffie, Darrell, 2003. "Intertemporal asset pricing theory," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, edition 1, volume 1, chapter 11, pages 639-742, Elsevier.
    15. Reisz, Alexander S. & Perlich, Claudia, 2007. "A market-based framework for bankruptcy prediction," Journal of Financial Stability, Elsevier, vol. 3(2), pages 85-131, July.
    16. Dumitrescu, Ariadna, 2007. "Valuation of defaultable bonds and debt restructuring," Journal of Corporate Finance, Elsevier, vol. 13(1), pages 94-111, March.
    17. Adriana Breccia & William Perraudin, 2010. "Debt Valuation and Chapter 22," Birkbeck Working Papers in Economics and Finance 1015, Birkbeck, Department of Economics, Mathematics & Statistics.
    18. Ericsson, Jan & Jacobs, Kris & Oviedo, Rodolfo, 2009. "The Determinants of Credit Default Swap Premia," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 44(1), pages 109-132, February.
    19. Sheen X. Liu & Howard Qi & Chunchi Wu, 2006. "Personal Taxes, Endogenous Default, and Corporate Bond Yield Spreads," Management Science, INFORMS, vol. 52(6), pages 939-954, June.
    20. Michael Jacobs, Jr, 2011. "An option theoretic model for ultimate loss-given-default with systematic recovery risk and stochastic returns on defaulted debt," BIS Papers chapters, in: Bank for International Settlements (ed.), Portfolio and risk management for central banks and sovereign wealth funds, volume 58, pages 257-285, Bank for International Settlements.

    More about this item

    Keywords

    Credit risk; Recovery rates; Bankruptcy; Debt default;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:jfinec:v:142:y:2021:i:3:p:1092-1108. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/inca/505576 .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.