Capital Structure and Asset Prices: Some Effects of Bankruptcy Procedures

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Capital Structure and Asset Prices: Some Effects of Bankruptcy Procedures

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

April 2002

Abstract: This paper examines the impact of the U.S. bankruptcy procedures on the valuation of corporate securities and capital structure decisions. We provide closed-form solutions for the values of corporate debt and equity when defaulting firms can either liquidate their assets or renegotiate outstanding debt under the Court protection. The paper shows that the possibility to renegotiate the debt contract (i) has an ambiguous impact on leverage choices and (ii) unambiguously increases credit spreads on corporate debt. The analysis also reveals that 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. 387-412.

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