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A "wreckers theory" of financial distress

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  • von Kalckreuth, Ulf

Abstract

In recent years, a number of papers have established a new empirical regularity. Stocks of distressed firms vastly underperform those of financially healthy firms. It is not necessary to attribute the negative excess returns of distressed firms to inefficient or irrational markets. We show that negative excess returns are the equilibrium outcome when a subset of participants is able to draw returns "in kind" from distressed companies. For firms close to bankruptcy, non-cash returns to ownership will be the dominant form of return to equity. If markets expect a contest for control, these returns will show up in stock valuation. The governance problem described here creates a link between the financial position of a firm and real allocation that may amplify macroeconomic real or financial shocks. --

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Bibliographic Info

Paper provided by Deutsche Bundesbank, Research Centre in its series Discussion Paper Series 1: Economic Studies with number 2005,40.

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Date of creation: 2005
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Handle: RePEc:zbw:bubdp1:4234

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Keywords: stock market anomalies; default risk; private benefits; moral hazard; limited liability;

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