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Liquidation Triggers and the Valuation of Equity and Debt

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  • Dan Galai

    (The Hebrew University Business school)

  • Alon Raviv

    (The Hebrew University Business school)

  • Zvi Wiener

    (The Hebrew University Business school)

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.

Suggested Citation

  • Dan Galai & Alon Raviv & Zvi Wiener, 2003. "Liquidation Triggers and the Valuation of Equity and Debt," Finance 0305002, EconWPA.
  • Handle: RePEc:wpa:wuwpfi:0305002
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    References listed on IDEAS

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    Cited by:

    1. Annabi, Amira & Breton, Michèle & François, Pascal, 2012. "Resolution of financial distress under Chapter 11," Journal of Economic Dynamics and Control, Elsevier, vol. 36(12), pages 1867-1887.
    2. Christensen, Peter Ove & Flor, Christian Riis & Lando, David & Miltersen, Kristian R., 2014. "Dynamic capital structure with callable debt and debt renegotiations," Journal of Corporate Finance, Elsevier, vol. 29(C), pages 644-661.
    3. Galai, Dan & Wiener, Zvi, 2008. "Stakeholders and the composition of the voting rights of the board of directors," Journal of Corporate Finance, Elsevier, vol. 14(2), pages 107-117, April.
    4. Liu, Liang-Chih & Dai, Tian-Shyr & Wang, Chuan-Ju, 2016. "Evaluating corporate bonds and analyzing claim holders’ decisions with complex debt structure," Journal of Banking & Finance, Elsevier, vol. 72(C), pages 151-174.
    5. Roman N. Makarov, 2016. "Modeling liquidation risk with occupation times," International Journal of Financial Engineering (IJFE), World Scientific Publishing Co. Pte. Ltd., vol. 3(04), pages 1-11, December.
    6. Ayadi, Mohamed A. & Ben-Ameur, Hatem & Fakhfakh, Tarek, 2016. "A dynamic program for valuing corporate securities," European Journal of Operational Research, Elsevier, vol. 249(2), pages 751-770.
    7. Winsen, Joseph K., 2010. "An overview of project finance binomial loan valuation," Review of Financial Economics, Elsevier, vol. 19(2), pages 84-89, April.
    8. Annabi, Amira & Breton, Michèle & François, Pascal, 2012. "Game theoretic analysis of negotiations under bankruptcy," European Journal of Operational Research, Elsevier, vol. 221(3), pages 603-613.
    9. Dionne, Georges & Laajimi, Sadok, 2012. "On the determinants of the implied default barrier," Journal of Empirical Finance, Elsevier, vol. 19(3), pages 395-408.
    10. Bruche, Max & Naqvi, Hassan, 2010. "A structural model of debt pricing with creditor-determined liquidation," Journal of Economic Dynamics and Control, Elsevier, vol. 34(5), pages 951-967, May.
    11. Reisz, Alexander S. & Perlich, Claudia, 2007. "A market-based framework for bankruptcy prediction," Journal of Financial Stability, Elsevier, vol. 3(2), pages 85-131, July.
    12. Martina Nardon, 2005. "Valuing defaultable bonds: an excursion time approach," Finance 0511015, EconWPA.
    13. Stefano Giglio & Kelly Shue, 2013. "No News is News: Do Markets Underreact to Nothing?," NBER Working Papers 18914, National Bureau of Economic Research, Inc.
    14. Lee, Cheng-Few & Lee, Kin-Wai & Yeo, Gillian Hian-Heng, 2009. "Investor protection and convertible debt design," Journal of Banking & Finance, Elsevier, vol. 33(6), pages 985-995, June.
    15. Abínzano, Isabel & Seco, Luis & Escobar, Marcos & Olivares, Pablo, 2009. "Single and Double Black-Cox: Two approaches for modelling debt restructuring," Economic Modelling, Elsevier, vol. 26(5), pages 910-917, September.
    16. Maclachlan, Iain C, 2007. "An empirical study of corporate bond pricing with unobserved capital structure dynamics," MPRA Paper 28416, University Library of Munich, Germany.
    17. Abel Elizalde, 2006. "Credit Risk Models Ii: Structural Models," Working Papers wp2006_0606, CEMFI.
    18. Makarov, R. & Metzler, A. & Ni, Z., 2015. "Modelling default risk with occupation times," Finance Research Letters, Elsevier, vol. 13(C), pages 54-65.

    More about this item

    Keywords

    default; bankruptcy; liquidation trigger; debt pricing; corporate finance;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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