Corporate Walkout Decisions and the Value of Default

We present a continuous-time asset pricing model of the levered firm where shareholders select not only the timing but also the form of control transfers. Owners are allowed to walk out of the firm either by (I) defaulting on their debt obligations or (ii) selling the firm with its debt obligations, as in a corporation sale. The structural model relates shareholders ex-post choice to both technological and financial factors. We obtain that the likelihood of default being chosen instead of a corporation sale increases with (I) the degree of leverage displayed by the firm and (ii) its technological supremacy in the industry. Moreover, whereas default necessarily involves inefficient timing of ownership transfers, corporation sales eliminate agency costs and achieve the correct allocation of resources. By ignoring such direct sales of ownership rights, existing defaultable bond pricing models thus often exaggerate risk premia and under-estimate the borrowing ability (debt capacity) of firms.