Capital Structure and Asset Prices: Some Effects of Bankruptcy Procedures

by Pascal François of HEC Montreal, and
Erwan Morellec of the University of Lausanne, University of Rochester, & FAME

April 2004

Abstract: We examine the impact of the U.S. bankruptcy procedure on the valuation of corporate securities and capital structure decisions. We provide closed-form solutions for corporate debt and equity values when defaulting firms can either liquidate their assets or renegotiate outstanding debt under court protection. We show that the possibility to renegotiate the debt contract (i) has an ambiguous impact on leverage choices and (ii) increases credit spreads on corporate debt. The sharing rule of cash flows during bankruptcy has a large impact on optimal leverage. By contrast, credit spreads on corporate debt show little sensitivity to this very parameter.

JEL Classification: G12, G32, G33.

Published in: Journal of Business, Vol. 77, No. 2, (April 2004), pp. 387-411.

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