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Liquidation Triggers and the Valuation of Equity and Debt

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Author Info
Dan Galai (The Hebrew University Business school)
Alon Raviv (The Hebrew University Business school)
Zvi Wiener (The Hebrew University Business school)

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Abstract

Net-worth covenants, as introduced by Black and Cox (1976), provide the firm’s bondholders with the right to force reorganization or liquidation if the value of the firm falls below a certain threshold. In the event of default, however, many bankruptcy codes stipulate an automatic stay of assets that prevent bondholders from triggering liquidation and thus impact many positive net-worth covenants. To consider this impact on a corporation’s capital structure we develop a general model of liquidation driven by a liquidation trigger. This trigger accumulates with time and severity of distress. In addition, current distress periods may have greater weight than old ones. The tractability of the approach stems from its ability to allow parameters appropriate for different legal rules and types of bondholder safety covenants. The proposed model includes several well-known models, like Merton, Black- Cox and others. We show how to valuate various types of corporate securities by using this model. Numerical results and sensitivity analysis are presented for selected basic cases.

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Paper provided by EconWPA in its series Finance with number 0305002.

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Date of creation: 14 May 2003
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Handle: RePEc:wpa:wuwpfi:0305002

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Web page: http://129.3.20.41

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Related research
Keywords: default; bankruptcy; liquidation trigger; debt pricing; corporate finance;

Other versions of this item:

Find related papers by JEL classification:
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Capital and Ownership Structure
G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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  4. Bebchuk, Lucian Ayre & Chang, Howard F, 1992. "Bargaining and the Division of Value in Corporate Reorganization," Journal of Law, Economics and Organization, Oxford University Press, vol. 8(2), pages 253-79, April.
    Other versions:
  5. 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. [Downloadable!] (restricted)
  6. Anderson, Ronald W & Sundaresan, Suresh, 1996. "Design and Valuation of Debt Contracts," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 9(1), pages 37-68. [Downloadable!] (restricted)
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  8. Lucian Arye Bebchuk, 2001. "Ex Ante Costs of Violating Absolute Priority in Bankruptcy," NBER Working Papers 8388, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  9. Merton, Robert C., 1973. "On the pricing of corporate debt: the risk structure of interest rates," Working papers 684-73., Massachusetts Institute of Technology (MIT), Sloan School of Management. [Downloadable!]
    Other versions:
  10. Morse, Dale & Shaw, Wayne, 1988. " Investing in Bankrupt Firms," Journal of Finance, American Finance Association, vol. 43(5), pages 1193-1206, December. [Downloadable!] (restricted)
  11. Leland, Hayne E, 1994. " Corporate Debt Value, Bond Covenants, and Optimal Capital Structure," Journal of Finance, American Finance Association, vol. 49(4), pages 1213-52, September. [Downloadable!] (restricted)
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  12. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June. [Downloadable!] (restricted)
  13. Ericsson, Jan & Reneby, Joel, 1995. "A Framework for Valuing Corporate Securities," Working Paper Series in Economics and Finance 89, Stockholm School of Economics, revised Oct 1998. [Downloadable!]
    Other versions:
  14. 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 351-67, May. [Downloadable!] (restricted)
  15. Lucian Arye Bebchuk, 1998. "Chapter 11," NBER Working Papers 6473, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  16. Jean Helwege, 1999. "How Long Do Junk Bonds Spend in Default?," Journal of Finance, American Finance Association, vol. 54(1), pages 341-357, 02. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Martina Nardon, 2005. "Valuing defaultable bonds: an excursion time approach," Finance 0511015, EconWPA. [Downloadable!]
  2. Abel Elizalde, 2006. "Credit Risk Models Ii: Structural Models," Working Papers wp2006_0606, CEMFI. [Downloadable!]
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