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A Real Options Approach to Bankruptcy Costs: Evidence from Failed Commercial Banks During the 1990s

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Joseph R. Mason
Abstract

Literature to date has identified three main aspects of liquidation time: firm size, asset specificity, and industry concentration. The present paper unifies the theory behind these three aspects of bankruptcy costs by treating them as components of a broader option valuation problem faced by the liquidating trustee. In the options valuation framework, at time t the trustee may choose to 1) liquidate at current asset values and incur a known loss, or 2) hold until the next period t+1 at a positive opportunity cost. The trustee may not sell in the current period if expected asset price growth is sufficiently large. Expectations of asset price growth are based on previous asset price growth and asset price volatility, which are related to firm size, asset specificity, and industry concentration. Testing the hypothesized asset price relationships on FDIC failed bank liquidation data with OLS, three-stage least squares, and duration specifications yields the appropriate results. Furthermore, it appears that liquidation time alone can be used as an effective second order proxy for asset value growth where market value estimates are unavailable.

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Paper provided by Wharton School Center for Financial Institutions, University of Pennsylvania in its series Center for Financial Institutions Working Papers with number 02-20.

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Date of creation: Mar 2002
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Handle: RePEc:wop:pennin:02-20

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  6. Calomiris, Charles W & Kahn, Charles M, 1991. "The Role of Demandable Debt in Structuring Optimal Banking Arrangements," American Economic Review, American Economic Association, vol. 81(3), pages 497-513, June. [Downloadable!] (restricted)
  7. Alderson, Michael J. & Betker, Brian L., 1995. "Liquidation costs and capital structure," Journal of Financial Economics, Elsevier, vol. 39(1), pages 45-69, September. [Downloadable!] (restricted)
  8. Kane, Edward J, 1990. " Principal-Agent Problems in S&L Salvage," Journal of Finance, American Finance Association, vol. 45(3), pages 755-64, July. [Downloadable!] (restricted)
  9. Kiefer, Nicholas M, 1988. "Economic Duration Data and Hazard Functions," Journal of Economic Literature, American Economic Association, vol. 26(2), pages 646-79, June. [Downloadable!] (restricted)
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