Bankruptcy Codes, Liquidation Timing, and Debt Valuation

by Max Bruche of CEMFI

July 2009

Abstract: This paper derives closed-form solutions for values of debt and equity in a continuous-time structural model in which the demands of creditors to be repaid cause a firm to be put into bankruptcy. This allows discussing the effect of creditor coordination in recovering money on the values of debt, equity, and the firm. The effects of features of bankruptcy codes that influence creditor coordination such as automatic stays and preference law are also considered. In the model, a lack of creditor coordination reduces the value of debt, but can increase the value of the firm. Automatic stays and preference law increase the value of equity, but can decrease the value of debt and the firm.

JEL Classification: G32, G33, G13, C72.

Keywords: Asset pricing, real options, bankruptcy, liquidation, coordination failure, global games, capital structure.

Forthcoming in: Journal of Financial and Quantitative Analysis.

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