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The Information Value of Distress

Author

Listed:
  • Christian Hilpert

    (Lingnan College, Sun Yat-sen University, 510275 Guangzhou, China)

  • Stefan Hirth

    (Department of Economics and Business Economics, Aarhus University and Danish Finance Institute, 8210 Aarhus V, Denmark)

  • Alexander Szimayer

    (Faculty of Business, Economics and Social Sciences, Universität Hamburg, 20146 Hamburg, Germany)

Abstract

We propose a novel framework for investigating learning dynamics on the debt market. Observing a firm’s survival of apparently distressed periods, the market eliminates asset value estimates that are too low to be consistent with the observed survival. Therefore, the firm’s cost of debt becomes lower for given financials. Relative to a perfect information setting, the firm strategically delays default to benefit from a subsequently lower cost of debt. Default comes as a surprise, as it reveals the currently worst possible asset value as correct. The surprise effect is mitigated for debt with higher performance sensitivity and for lower ex ante information asymmetry.

Suggested Citation

  • Christian Hilpert & Stefan Hirth & Alexander Szimayer, 2024. "The Information Value of Distress," Management Science, INFORMS, vol. 70(1), pages 78-97, January.
    • Handle: RePEc:inm:ormnsc:v:70:y:2024:i:1:p:78-97
    DOI: 10.1287/mnsc.2022.4632
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