Liquidation Triggers and the Valuation of Equity and Debt
by Dan Galai of the Hebrew University of Jerusalem & New York University,
January 26, 2006
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. 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.
Keywords: bankruptcy, liquidation trigger, debt pricing, Assets pricing.
Published in: Journal of Banking & Finance, Vol. 31, No. 12, (December 2007), pp. 3604-3620.