Capital Structure and Asset Prices: Some Effects of Bankruptcy Procedures

Liquidation triggers and the valuation of equity and debt

“…We show that by applying the appropriate liquidation parameters, our model converges to the François and Morellec (2004) model also accommodates Moraux's (2004) bankruptcy model, which assumes that liquidation occurs when total excursion time exceeds a pre-determined grace period. While these two models may accurately describe the bankruptcy procedure for a specific set of legal regime and law enforcement, our model, as illustrated in this paper, covers a wider array of legal precepts and contractual arrangements.…”

“…In contrast, our model takes into account the effect of the severity of the distress event on the decision to liquidate a firm's assets. Moreover, all the models mentioned above (Merton, 1974;Black and Cox, 1976;François and Morellec, 2004;Moraux, 2004;Fan and Sundaresan, 2000), as well as other models (Leland, 1994;Anderson and Sundaresan, 1996), are special cases of our general model. Its generality comes at the cost of being able to solve the model only numerically but not analytically.…”

“…When b ! +1 and c = 0, the liquidation procedure occurs at the first point in time when the firm value process has spent consecutively more than the pre-specified grace period below the threshold K t and we get the François and Morellec (2004) consecutive excursion method procedure. At one extreme, when d = 0, the FM model is similar, as a special case, to the standard modeling of default and liquidation (see Leland, 1994).…”

Managerial entrenchment, equity payout and capital structure

“…Leland (1998) and Ericsson (2000) study the effects of asset substitution and hedging policies. Francois and Morellec (2004) and Broadie et al (2007) examine the impact of default procedures, and Morellec (2004) gauges the manager-shareholder conflicts through managerial incentives for over-investment. 3 This assumption creates an upper boundary for the agency cost of equity.…”

Why adding firm value with a put feature in debt contracts is better than renegotiation

“…Likewise, a default of the firm does not necessarily take place once the firm triggers a default. It is also possible that a stop 3 Francois and Morellec (2004) extend the renegotiation idea of Fan and Sundaresan (2000) by introducing a finite time period in which renegotiation takes place. A further extension is from Euraslan (2008) and Annab and Francois (2007) who consider the more complex form of renegotiation with both senior and junior debt holders.…”