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Market implied costs of bankruptcy

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  • Reindl, Johann
  • Stoughton, Neal
  • Zechner, Josef

Abstract

This paper takes a novel approach to estimating bankruptcy costs by inference from market prices of equity and put options using a dynamic structural model of capital structure. This approach avoids the selection bias of looking at firms in or near default and therefore permits theories of ex ante capital structure determination to be tested. We identify significant cross sectional variation in bankruptcy costs across industries and relate these to specific firm characteristics. We find that asset volatility and growth options have significant positive impacts, while tangibility and size have negative impacts. Our bankruptcy cost variable estimate significantly negatively impacts leverage ratios. This negative impact is in addition to that of other firm characteristics such as asset intangibility and asset volatility. The results provide strong support for the tradeoff theory of capital structure. --

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Paper provided by Center for Financial Studies (CFS) in its series CFS Working Paper Series with number 2013/27.

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Date of creation: 2013
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Handle: RePEc:zbw:cfswop:201327

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  1. Leland, Hayne E & Toft, Klaus Bjerre, 1996. " Optimal Capital Structure, Endogenous Bankruptcy, and the Term Structure of Credit Spreads," Journal of Finance, American Finance Association, vol. 51(3), pages 987-1019, July.
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  3. Murray Z. Frank & Vidhan K. Goyal, 2009. "Capital Structure Decisions: Which Factors Are Reliably Important?," Financial Management, Financial Management Association International, vol. 38(1), pages 1-37, 03.
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  9. Weiss, Lawrence A., 1990. "Bankruptcy resolution: Direct costs and violation of priority of claims," Journal of Financial Economics, Elsevier, vol. 27(2), pages 285-314, October.
  10. Eugene F. Fama & Kenneth R. French, . "Testing Tradeoff and Pecking Order Predictions about Dividends and Debt.”," CRSP working papers 506, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
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  12. Sergei A. Davydenko & Ilya A. Strebulaev & Xiaofei Zhao, 2012. "A Market-Based Study of the Cost of Default," Review of Financial Studies, Society for Financial Studies, vol. 25(10), pages 2959-2999.
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  14. Jan Ericsson & Joel Reneby, 1998. "A framework for valuing corporate securities," Applied Mathematical Finance, Taylor & Francis Journals, vol. 5(3-4), pages 143-163.
  15. Jan Ericsson & Joel Reneby, 2003. "Stock options as barrier contingent claims," Applied Mathematical Finance, Taylor & Francis Journals, vol. 10(2), pages 121-147.
  16. Peter Carr & Liuren Wu, 2010. "Stock Options and Credit Default Swaps: A Joint Framework for Valuation and Estimation," Journal of Financial Econometrics, Society for Financial Econometrics, vol. 8(4), pages 409-449, Fall.
  17. Heitor Almeida & Murillo Campello, 2007. "Financial Constraints, Asset Tangibility, and Corporate Investment," Review of Financial Studies, Society for Financial Studies, vol. 20(5), pages 1429-1460, 2007 12.
  18. Elkamhi, Redouane & Ericsson, Jan & Parsons, Christopher A., 2012. "The cost and timing of financial distress," Journal of Financial Economics, Elsevier, vol. 105(1), pages 62-81.
  19. Ang, James S & Chua, Jess H & McConnell, John J, 1982. " The Administrative Costs of Corporate Bankruptcy: A Note," Journal of Finance, American Finance Association, vol. 37(1), pages 219-26, March.
  20. Arturo Bris & Ivo Welch & Ning Zhu, 2006. "The Costs of Bankruptcy: Chapter 7 Liquidation versus Chapter 11 Reorganization," Journal of Finance, American Finance Association, vol. 61(3), pages 1253-1303, 06.
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