Liquidation triggers and the valuation of equity and debt

Dan Galai*, Alon Raviv, Zvi Wiener

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

30 Scopus citations

Abstract

Many bankruptcy codes implicitly or explicitly contain net-worth covenants, which 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 practice, however, default does not necessarily lead to immediate change of control or to liquidation of the firm's assets by its debtholders. To consider the impact of this on the valuation of corporate securities, we develop a model in which liquidation is driven by a state variable that accumulates with time and severity of distress. We model a dynamic grace period for the liquidation event. Recent or severe distress events may have greater impact on the liquidation trigger. Our model can be applied to a wide array of bankruptcy codes and jurisdictions.

Original languageAmerican English
Pages (from-to)3604-3620
Number of pages17
JournalJournal of Banking and Finance
Volume31
Issue number12
DOIs
StatePublished - Dec 2007

Bibliographical note

Funding Information:
We are grateful to Menahem Brenner, Christian Riis Flor, Pascal François, Eugene Kandel, Alexander Reisz, Orly Sade, Oren Sussman as well as seminar participants at the EFA Meetings in Moscow, the EFMA meeting in Milan, the Third World Congress of the Bachelier Finance Society in Chicago, the Second International Conference on Credit in HEC Montreal, the Eighth Annual Conference on Finance and Accounting in Tel Aviv, the Hebrew University, HEC Lausanne and Manitoba University for helpful comments. Galai and Wiener acknowledge grants from the Zagagi Center and the Krueger Center at the Hebrew University.

Keywords

  • Asset pricing
  • Bankruptcy
  • Debt pricing
  • Dynamic grace period
  • Liquidation trigger

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