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The Valuation of Corporate Debt with Default Risk

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  • Hassan Naqvi

    (NUS Business School, & Financial Markets Group, LSE)

Abstract

This article values equity and corporate debt by taking into account the fact that in practice the default point differs from the liquidation point and that it might be in the creditors' interest to delay liquidation. The article develops a continuous time asset pricing model of debt restructuring which explicitly considers the inalienability of human capital. The study finds that even though in general the creditors will not liquidate the firm on the incidence of default, but nevertheless would liquidate the firm prematurely relative to the first best threshold. This agency problem leads to the breakdown of the capital structure irrelevance result.

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File URL: http://128.118.178.162/eps/fin/papers/0410/0410010.pdf
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Bibliographic Info

Paper provided by EconWPA in its series Finance with number 0410010.

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Length: 26 pages
Date of creation: 14 Oct 2004
Date of revision:
Handle: RePEc:wpa:wuwpfi:0410010

Note: Type of Document - pdf; pages: 26
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Web page: http://128.118.178.162

Related research

Keywords: Debt pricing; default risk; inalienability of human capital;

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References

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  1. 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.
  2. Mella-Barral, Pierre, 1999. "The Dynamics of Default and Debt Reorganization," Review of Financial Studies, Society for Financial Studies, vol. 12(3), pages 535-78.
  3. 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.
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  5. Hege, Ulrich & Mella-Barral, Pierre, 2000. "Collateral, Renegotiation And The Value Of Diffusely Held Debt," CEPR Discussion Papers 2417, C.E.P.R. Discussion Papers.
  6. Hart, Oliver & Moore, John, 1994. "A Theory of Debt Based on the Inalienability of Human Capital," The Quarterly Journal of Economics, MIT Press, vol. 109(4), pages 841-79, November.
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  17. Jones, E Philip & Mason, Scott P & Rosenfeld, Eric, 1984. " Contingent Claims Analysis of Corporate Capital Structures: An Empirical Investigation," Journal of Finance, American Finance Association, vol. 39(3), pages 611-25, July.
  18. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, vol. 3(4), pages 305-360, October.
  19. Pierre Mella-Barral & William R M Perraudin, 1993. "Strategic Debt Service," CEPR Financial Markets Paper 0039, European Science Foundation Network in Financial Markets, c/o C.E.P.R, 77 Bastwick Street, London EC1V 3PZ.
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Citations

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Cited by:
  1. Stephen D. Smith & Larry D. Wall, 2005. "Debt, hedging, and human capital," Working Paper 2005-30, Federal Reserve Bank of Atlanta.
  2. Abel Elizalde, 2007. "From Basel I To Basel Ii: An Analysis Of The Three Pillars," Working Papers wp2007_0704, CEMFI.

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