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Valuation of the Firm's Liabilities when Equity Holders are also Creditors

  • Marco Realdon

This paper presents a tractable structural model whereby controlling equity holders are also among the creditors of the firm. As the firm approaches distress, equity holders can depauperate the firm and expropriate other creditors by repaying their credit before bankruptcy. The bankruptcy court's right to revoke such repayment protects arm's length creditors, reduces the cost of borrowing and induces equity holders to anticipate repayment of their credit. Equity holders decide repayment neither too early nor too late, so as to reduce the risk of repayment revocation by the bankruptcy court. Similar conclusions apply to the preferential repayment of bank loans personally guaranteed by equity holders. The analysis also suggests that callable bearer bonds may be more valuable to equity holders than to other creditors.

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Paper provided by Department of Economics, University of York in its series Discussion Papers with number 06/16.

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Date of creation: Aug 2006
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Handle: RePEc:yor:yorken:06/16
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Department of Economics and Related Studies, University of York, York, YO10 5DD, United Kingdom

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