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  5. Bankruptcy and Distress
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Bankruptcy and Distress

Paper Session

Sunday, Jan. 3, 2021 12:15 PM - 2:15 PM (EST)

Hosted By: American Finance Association
  • Chair: Edith Hotchkiss, Boston College

Large Shareholders and Financial Distress

Christian Opp
,
University of Rochester

Abstract

Blockholders play a prominent role in distressed firms' access to finance. I develop a dynamic model of the interaction between these investors and distressed firms to examine blockholders' impact on efficiency and the distribution of value. The model captures key empirical facts on distressed equity issuances, including the provision of substantial discounts to large investors. Blockholders' impact on debt overhang problems is generically non-monotone. Whereas inefficiencies are exacerbated for intermediate levels of distress, they are alleviated in deep distress, when blocks are acquired in last-minute interventions. The paper proposes a novel set of modeling tricks that yield global solutions in environments with optimal default and learning, while only requiring the inversion of sparse matrices.

Dark Knights: The Rise in Firm Intervention by CDS Investors

Andras Danis
,
Georgia Institute of Technology
Andrea Gamba
,
University of Warwick

Abstract

We document an increase in cases where credit default swap (CDS) investors intervene in the restructuring of a distressed firm. In our theoretical analysis, we show that—contrary to popular belief—intervention by CDS investors is not necessarily reducing firm value. While the equilibrium CDS spread seems excessive for the protection buyer, that cost is offset by the reduced probability of liquidation. Ex ante borrowing costs go down, and investment and firm value both increase. Under certain assumptions, investment reaches first-best. Our results suggest that the empty creditor problem could be at least partially solved by CDS investor intervention.

How Large are Pre-default Costs of Financial Distress? Estimates from a Dynamic Model

Redouane Elkamhi
,
University of Toronto
Marco Salerno
,
University of Toronto

Abstract

We estimate the costs of financial distress prior to default (pre-default costs) separately from the loss incurred at default (the loss given default) using a dynamic trade-off model of capital structure. We document that pre-default costs are on average equal to 6.5% of firm value per year, which translates into approximately 5.5% of the ex-ante firm value. Our study shows that accounting for pre-default costs significantly improves the ability of a trade-off model to match the empirically observed levels of leverage, default rates and loss incurred at default. Last, we show that the expected pre-default costs of financial distress vary significantly across industries, and are higher for firms that produce durable products.

Revisiting the Asset Fire Sale Discount: Evidence from Commercial Aircraft Sales

Julian Franks
,
London Business School
Gunjan Seth
,
London Business School
Oren Sussman
,
University of Oxford
Vikrant Vig
,
London Business School

Abstract

This paper uses commercial aircraft transactions to isolate empirically the fire sale discount from the quality impairment discount on aircraft sold by distressed airlines. Results indicate that financially distressed airlines sell low quality aircraft that have been under-maintained, and as a result, have lower life expectancy and lower utilization rates compared with aircraft sold by healthy airlines. This quality impairment can explain around half of the raw liquidation discount. Furthermore, it does not seem to be the case that a forced sale of aircraft generates ex-post inefficiency as far as the allocation of aircraft is concerned. The quality adjusted fire sale discount captures a liquidity discount – a transfer from the seller to the buyer, likely driven by the reduced bargaining power of the seller. Our results indicate that the welfare costs linked to fire sales are lower than previously suggested in the literature.
Discussant(s)
Daniel Green
,
Harvard Business School
Jason R. Donaldson
,
Washington University in St. Louis
Dirk Hackbarth
,
Boston University
Carola Schenone
,
University of Virginia
JEL Classifications
  • G3 - Corporate Finance and Governance