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Capital Structure and Debt Priority

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  • Sami Attaoui
  • Patrice Poncet

Abstract

We study a defaultable firm's debt priority structure in a simple structural model where the firm issues senior and junior bonds and is subject to both liquidity and solvency risks. Assuming that the absolute priority rule prevails and that liquidation is immediate upon default, we determine the firm's interior optimal priority structure along with its optimal capital structure. We also obtain closed-form solutions for the market values of the firm's debt and equity. We find that the magnitude of the spread differential between junior and senior bond yields is positively, but not linearly related to the total debt level and the riskiness of assets. Finally, we provide an in-depth analysis of probabilities of default and the term structure of credit spreads.
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Suggested Citation

  • Sami Attaoui & Patrice Poncet, 2013. "Capital Structure and Debt Priority," Financial Management, Financial Management Association International, vol. 42(4), pages 737-775, December.
  • Handle: RePEc:bla:finmgt:v:42:y:2013:i:4:p:737-775
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    File URL: http://hdl.handle.net/10.1111/fima.2013.42.issue-4
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    Cited by:

    1. Quratulain Zafar & Winai Wongsurawat & David Camino, 2019. "The determinants of leverage decisions: Evidence from Asian emerging markets," Cogent Economics & Finance, Taylor & Francis Journals, vol. 7(1), pages 1598836-159, January.
    2. de La Bruslerie, Hubert & Gueguen, Simon, 2021. "Creditors’ holdup, releveraging and the setting of private appropriation in a control contract between shareholders," International Review of Law and Economics, Elsevier, vol. 68(C).
    3. Liu, Liang-Chih & Dai, Tian-Shyr & Wang, Chuan-Ju, 2016. "Evaluating corporate bonds and analyzing claim holders’ decisions with complex debt structure," Journal of Banking & Finance, Elsevier, vol. 72(C), pages 151-174.
    4. Mirza, Nawazish & Rahat, Birjees & Naqvi, Bushra & Rizvi, Syed Kumail Abbas, 2023. "Impact of Covid-19 on corporate solvency and possible policy responses in the EU," The Quarterly Review of Economics and Finance, Elsevier, vol. 87(C), pages 181-190.
    5. Attaoui, Sami & Poncet, Patrice, 2015. "Write-Down Bonds and Capital and Debt Structures," Journal of Corporate Finance, Elsevier, vol. 35(C), pages 97-119.
    6. Sami Attaoui, 2016. "Capital Structure And Tax Convexity When The Maturity Of Debt Is Finite," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 19(01), pages 1-20, February.
    7. de La Bruslerie, Hubert, 2016. "Does debt curb controlling shareholders' private benefits? Modelling in a contingent claim framework," Economic Modelling, Elsevier, vol. 58(C), pages 263-282.

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