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Previous studies targeting accuracy improvement of default models mainly focused on the choice of the explanatory variables and the statistical approach. We alter the focus to the choice of the dependent variable. We particularly explore whether the common practice (in literature) of using proxies for default events (bankruptcy or delisting) to increase sample size indeed improves accuracy. We examine four definitions of financial distress and show that each definition carries considerably different characteristics. We discover that rating agencies effort to measure correctly the timing of default is valuable. In predicting default and in explaining CDS spreads, a default model significantly outperforms any other type of financial-distress model, despite being estimated on a substantially smaller sample (72 defaults compared to 409 bankruptcies and 923 delistings).

We analyze government interventions to recapitalize a banking sector that restricts lending to firms because of debt overhang. We find that the efficient recapitalization program injects capital against preferred stock plus warrants and conditions implementation on sufficient bank participation. Preferred stock plus warrants reduces opportunistic participation by banks that do not require recapitalization, while conditional implementation limits free riding by banks that benefit from lower credit risk because of other banks' participation. Efficient recapitalization is profitable if the benefits of lower aggregate credit risk exceed the cost of implicit transfers to bank debt holders.

En utilisant une structure des etats financiers des banques qui tient compte de leurs expositions bilaterales en termes d’actions et de prets, on developpe un modele structurel de faillite. Ce modele permet de distinguer les facteurs exogenes et endogenes dont depend la faillite. On prouve l’existence et l’unicite de l’equilibre de liquidation, on etudie les consequences des chocs exogenes sur le systeme bancaire, et on mesure le phenomene de contagion. On illustre l’usage de cette approche en l’appliquant au systeme bancaire francais.

Our model shows that deterioration in debt market liquidity leads to an increase in not only the liquidity premium of corporate bonds but also credit risk. The latter effect originates from firms’ debt rollover. When liquidity deterioration causes a firm to suffer losses in rolling over its maturing debt, equity holders bear the losses while maturing debtholdersare paidinfull.Thisconflictleadsthefirmto defaultatahigher fundamental threshold. Our model demonstrates an intricate interaction between the liquidity premium and default premium and highlights the role of short-term debt in exacerbating rollover risk. THE YIELD SPREAD OF a firm’s bond relative to the risk-free interest rate directly determines the firm’s debt financing cost, and is often referred to as its credit spread. It is widely recognized that the credit spread reflects not only a default premium determined by the firm’s credit risk but also a liquidity premium due to illiquidity of the secondary debt market (e.g., Longstaff, Mithal, and Neis (2005) and Chen, Lesmond, and Wei (2007)). However, academics and policy makers tend to treat both the default premium and the liquidity premium as independent, and thus ignore interactions between them. The financial crisis of 2007 to 2008 demonstrates the importance of such an interaction— deterioration in debt market liquidity caused severe financing difficulties for many financial firms, which in turn exacerbated their credit risk. In this paper, we develop a theoretical model to analyze the interaction between debt market liquidity and credit risk through so-called rollover risk: when debt market liquidity deteriorates, firms face rollover losses from issuing new bonds to replace maturing bonds. To avoid default, equity holders need to bear the rollover losses, while maturing debt holders are paid in full. This

We study the implications of hedging for firm financing and investment. We do so using an extensive, hand-collected dataset on corporate hedging activities. Hedging can lower the odds of negative firm realizations, reducing the expected costs of financial distress. In theory, this should ease a firm's access to credit. Using a tax-based instrumental variable approach, we find that hedgers pay lower interest spreads and are less likely to have capital expenditure restrictions in their loan agreements. These favorable financing terms, in turn, allow hedgers to invest more. Our tests characterize two exact channels (cost of borrowing and investment restrictions) through which hedging affects corporate outcomes. The analysis we present shows that hedging has a first-order effect on firm financing and investment, and provides new insights into how hedging affects corporate wealth. More broadly, our study contributes novel evidence on the real consequences of financial contracting.

I build a dynamic capital structure model that demonstrates how business-cycle variations in expected growth rates, economic uncertainty, and risk premia influence firms’ financing and default policies. Countercyclical fluctuations in risk prices, default probabilities, and default losses arise endogenously through firms’ responses to the macroeconomic conditions. These comovements generate large credit risk premia for investment grade firms, which helps address the “credit spread puzzle” and “under-leverage puzzle” in a unified framework. The model generates interesting dynamics for financing and defaults, including “credit contagion” and market timing of debt issuance. It also provides a novel procedure to estimate state-dependent default losses., Katherine Dusak Miller Ph.D. Fellowship in Finance

This paper presents an equilibrium model of industry dynamics and capital structure decisions. The unique stationary equilibrium is derived in closed-form. The analysis reveals that the interaction between capital structure and production decisions influences the stationary distribution of surviving firms and their survival probabilities. Under reasonably calibrated parameter values, the model predicts a low industry average leverage ratio which is in line with that observed in practice. Comparative static analysis demonstrates that the model can generate the relation between capital structure and firms¡¯ entry, exit and production decisions documented in the evidence. The model also provides a number of new predictions regarding industry dynamics and capital structure.

Our model assumes that creditors need to expend resources to collect on claims. Consequently, because diffuse creditors suffer from mutual free-riding (Holmstrom (1982)), they fare worse than concentrated creditors (e.g., a house bank). The model predicts that measures of debt concentration relate positively to creditors’ (aggregate) debt collection expenditures and positively to management’s chosen expenditures to resist paying. However, collection activity is purely redistributive, so social waste is larger when creditors are concentrated. If borrower quality is not known, the best firms choose the most concentrated creditors and pay higher expected yields. COORDINATION FAILURE AMONG MULTIPLE CLAIMANTS ,b ethey creditors or owners, is a subject well studied in the academic literature. Such coordination failure can lead to takeover failures (Grossman and Hart (1980)) or bank-runs (e.g., Diamond and Dybvig (1983), Morris and Shin (1999)), or can generally reduce the probability of successful renegotiation to a proposed reorganization plan when renegotiation requires simultaneous assent by many claimants (e.g., �

In this paper, we develop a dynamic model that captures the interaction between a firm’s cash reserves, the risk management policy and the profitability of a non-predictable irreversible investment opportunity. We consider a firm that has assets in place generating a stochastic cash-flow stream. The firm has a non-predictable growth opportunity to expand its operation size by paying a sunk cost. When the opportunity is available, the firm can finance it either by cash or by costly equity issuance. We provide an explicit characterization of the firm strategy in terms of investment, hedging, equity issuance and dividend distribution.

Throughout Central and Eastern Europe (CEE), there is a widespread failure of enterprise debtors to make scheduled payments of principal and interest to creditors, who in turn have strong incentives not to declare bankruptcy. In such circumstances, the price mechanism does not properly guide the reallocation of resources. The normal process of exit in a market economy is suspended, and the disproportionate share of bank credit effectively going to refinancing of incumbents impedes entry. We argue that this may be the single most important obstacle to economic restructuring in CEE. We discuss the scope of and reasons for this problem; the inefficiencies it creates; and how to deal with it. We propose a sequencing of recapitalization of banks and of enterprises that is designed to be credible and robust to the incentive failures identified. We then assess the fiscal consequences of such a reform package and how it affects the conduct and effectiveness of monetary policy. We conclude that the international institutions must put the full weight of their authority and credibility behind such a package in order to break through the obstacles to successful restructuring.(This abstract was borrowed from another version of this item.)