Strategic Default and Equity Risk Across Countries

Abstract

This is the accepted version of the paper.This version of the publication may differ from the final published version. Permanent AbstractWe show that the prospect of a debt renegotiation favorable to shareholders reduces the Örmís equity risk. The equity beta and return volatility are lower in countries where the bankruptcy code favors debt renegotiations and for Örms with more shareholder bargaining power relative to debt holders. These relations weaken as the countryís insolvency procedure favors liquidations over renegotiations. In the limit, when debt contracts cannot be renegotiated, the equity risk is independent of shareholdersí incentives to default strategically. We argue that these Öndings support the hypothesis that the threat of strategic default can reduce the Örmís equity risk.

Debt enforcement, investment, and risk taking across countries

“…(see Favara, Schroth and Valta, 2012). While these studies assume that asset risk is given and independent of claimholders' expected recovery in default, we show that the prospect of an imperfect enforcement of debt contracts in default reduces asset risk.…”

Financing Investment: The Choice Between Bonds and Bank Loans

“…Denoting the bargaining power of shareholders in default by η ∈ [0, 1], the Nash bargaining solution implies that shareholders get a fraction ηα of asset value in default. We assume that renegotiations may fail with probability q, as in Davydenko and Strebulaev (2007) and Favara, Schroth, and Valta (2012).…”

Debt Renegotiation and Debt Overhang: Evidence from Lender Mergers

“…Other papers have also looked at the implications of debt enforcement or creditor rights on asset pricing (Garlappi, Shu, and Yan 2008, Garlappi and Yan 2011, Hackbarth, Haselmann, and Schoenherr 2015and Favara, Schroth, and Valta 2012. While these studies all take the asset side of the firms as given, I show in this paper that debt renegotiation can affect corporate investment, and hence the asset side of the balance sheet.…”