Recent Bankruptcy Finance-Related Articles of Interest Available for Downloading from SSRN

The following bankruptcy finance-related working papers, arranged by abstract ID number, can be downloaded from the Social Science Research Network:


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Santa Clara University's Yongtae Kim and Oklahoma State University's Sandeep Nabar: "Bankruptcy Probability Changes and the Differential informativeness of Bond Upgrades and Downgrades" (Abstract ID: 960751)

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Univ. of Minnesota's Paul Pover and Rakdeep Singh: "Sale-Backs in Bankruptcy" (Abstract ID: 956211):

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NYU School of Law's (and former classmate) Barry E. Adler: "Game-Theoretic Bankruptcy Valuation" (Abstract ID: 954147)

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Univ. of Westminster's John Flood: "The Vultures Fly East: The Creation and Globalization of the Distressed Debt Market" (Abstract ID: 949581)

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Univ. of Arizona's Andrew Zhang: "Distress Risk Premia in Stock and Bond Returns" (Abstract ID: 947844)

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Rice University's Evgeny Lyandres and George Mason University's Alexei Zhdanov: "Investment Opportunities and Bankruptcy Prediction" (Abstract ID: 946240)

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Univ. of Minnesota's Timothy J. Kehoe and UCLA's David K. Levine: "Bankruptcy and Collateral in Debt Constrained Markets" (Abstract ID: 940605)

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Univ. of Verona's Andrea Gamba and Daniele Poiega; Univ. of Navarra's Mamen Aranda: "Investment and Credit Risk: A Structural Approach" (Abstract ID: 945968) 

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Univ. of Chicago's Arthur G. Korteweg: "The Costs of Financial Distress across Industries" (Abstract ID: 945425

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UC San Diego's Michelle J. Waite: "Abuse or Protection?" (Abstract ID: 944916)

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NYU's Edward I. Altman and Brent Pasternack: "Defaults and Returns in the High Yield Bond Market: The Year 2005 in Review and Market Outlook" (Abstract ID: 943326)

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The inset graph is taken from a report to the FDIC Board of Directors dated May 9, 2006, entitled Economic Conditions and Emerging Risks in Banking, and is used to support the following point:

Improvement of the credit default settlement process is vital. Because of the growth in credit derivative contracts, market anomalies have occurred when corporations default or declare bankruptcy. A prime example is how corporate bonds of Delphi Corp. actually increased in value as traders bid up the price of bonds in order to physically settle credit derivative contracts.  Industry participants are committed to implementing new procedures for settlements following a credit event, providing for net cash settlement at a single auction-based price.

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Abstracts for each of these papers follow:

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Yongtae Kim and Sandeep Nabar, "Bankruptcy Probability Changes and the Differential informativeness of Bond Upgrades and Downgrades" (Abstract ID: 960751):

Prior studies have found that stock returns around announcements of bond upgrades are insignificant, but that stock prices respond negatively to announcements of bond downgrades. This asymmetric stock market reaction suggests either that bond downgrades are timelier than upgrades, or that voluntary disclosures by managers preempt upgrades but not downgrades. This study investigates these conjectures by examining changes in firms' probabilities of bankruptcy (assessed using bankruptcy prediction models) and voluntary disclosure activity around rating change announcements. The results indicate that the assessed probability of bankruptcy decreases before bond upgrades, but not after. By contrast, the assessed probability of bankruptcy increases both before and after bond downgrades. We also find that controlling for potential wealth-transfer related rating actions, which can impact stock returns differently, does not alter our results. Tests of press releases and earnings forecasts issued by firms suggest that the differential informativeness of upgrades and downgrades is not caused by differences in pre-rating change voluntary disclosures by upgraded and downgraded firms. The results support the hypothesis that downgrades are timelier than upgrades.

Paul Pover and Rakdeep Singh, "Sale-Backs in Bankruptcy" (Abstract ID: 956211):

When bankrupt firms are sold, they are often repurchased by their former owner or manager. These insiders are by default better informed than outsiders about the true value of the firm or its assets, so other potential buyers must worry about overpaying if they win. The presence of insiders may thus have a chilling effect on the bidding. We ask how insiders should be treated in bankruptcy sales: Should they be allowed to submit bids? If so, under what conditions? We derive properties of an optimal sale procedure and show that it must be biased against insiders. Specifically, it should be harder for insiders to win with low bids than for outsiders. We show that the market tests that are routinely required in bankruptcy sales are sub-optimal, since they treat all potential buyers alike and forgo the benefits of biasing the procedure against insiders.

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Barry E. Adler. "Game-Theoretic Bankruptcy Valuation" (Abstract ID: 954147):

The rules of bankruptcy reorganization in the United States permit a judge to permit a debtor's retention of collateral for a loan even over the objection of the secured creditor; the results may include continuation of inviable firms, violations of absolute priority, and high transactions cost. An alternative would grant a secured creditor the unfettered right to retain its collateral; the results might include liquidation of viable firms, violations of absolute priority, and high transactions cost. Proposed here is a mechanism that mediates between these imperfect options: junior interests would control the bankruptcy process and would, on behalf of the debtor, propose a reorganization plan that could include a take-it-or-leave-it offer for collateral, with certain liquidation of the collateral the consequence if the secured creditor rejects the plan. This process would preserve any significant debtor going-concern surplus and largely honor absolute priority. The mechanism would, therefore, promote ex post as well as ex ante efficiency. Moreover, because a take-it-or-leave-it-offer process neither requires negotiation nor permits litigation, the parties would be spared the risk of bargaining expense or breakdown and would be saved the cost of persuasion or proof with respect to values the parties know or can reasonably estimate.

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John Flood, "The Vultures Fly East: The Creation and Globalization of the Distressed Debt Market" (Abstract ID: 949581): 

Corporate insolvency and bankruptcy have given rise to new markets, including global ones, in which lawyers have been key players. This paper examines the role of lawyers in informal restructuring through an analysis of the London Approach and the rise of the distressed debt market.

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Andrew Zhang, "Distress Risk Premia in Stock and Bond Returns" (Abstract ID: 947844):

This paper documents negative distress risk premia in stock returns but positive premia in bond returns based on a joint study of stock and bond markets. Shareholders' controlling advantages over bondholders ex ante affect asset prices of distressed firms, but do not cause the negative distress risk premia in stock returns. I find no evidence that distressed firms are less risky than non-distressed firms after controlling for book-to-market and investment growth (Fama and French (2005)). My findings are consistent with the market segmentation assertion that distress risk is mispriced in the stock market but not in the bond market.

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Evgeny Lyandres and Alexei Zhdanov: "Investment Opportunities and Bankruptcy Prediction" (Abstract ID: 946240): 

A firm's mix of growth options and assets in place is an important determinant of its optimal default strategy. Our simple model shows that shareholders of a firm with valuable investment opportunities would be able/willing to wait longer before defaulting on their contractual debt obligations than shareholders of an otherwise identical firm without such opportunities. More importantly, we show empirically using a dataset of recent corporate bankruptcies that measures of investment opportunities are significantly related to bankruptcy. Augmenting existing bankruptcy prediction models by these measures improves their in-sample fit and out-of-sample forecasting ability.

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Timothy J. Kehoe and David K. Levine: "Bankruptcy and Collateral in Debt Constrained Markets" (Abstract ID: 940605):

Typical models of bankruptcy and collateral rely on incomplete asset markets. In fact, bankruptcy and collateral add contingencies to asset markets. In some models, these contingencies can be used by consumers to achieve the same equilibrium allocations as in models with complete markets. In particular, the equilibrium allocation in the debt constrained model of Kehoe and Levine (2001) can be implemented in a model with bankruptcy and collateral. The equilibrium allocation is constrained efficient. Bankruptcy occurs when consumers receive low income shocks. The implementation of the debt constrained allocation in a model with bankruptcy and collateral is fragile in the sense of Leijonhufvud`s "corridor of stability," however: If the environment changes, the equilibrium allocation is no longer constrained efficient.

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Andrea Gamba, Daniele Poiega and Mamen Aranda, "Investment and Credit Risk: A Structural Approach" (Abstract ID: 945968):

The paper investigates the impact on credit risk of capital structure choices driven by firm's investments and financing decisions. To this purpose we propose a dynamic structural model featuring endogenous investment, capital structure and default. Investments are partially irreversible and are financed with internal equity as well as by issuing bonds and shares. In case of financial distress, fire sales of capital are at a discount. The firm has a convex tax function and faces constant and proportional debt adjustment costs and equity flotation costs. Investors face personal taxes and, in case of default, bondholders pay bankruptcy costs.

We calibrate the model on accounting and market data. Using simulation, we test the fitting of standard metrics of credit worthiness, like interest rate coverage, default rate, and the distribution of firms across rating classes, produced by the model to the empirical metrics. To highlight the effect of different degree of flexibility on credit risk, the same results are obtained also with two simplified versions of the model, one with only exogenous investment, in line with Fischer, Heinkel, and Zechner (1989), and one with both exogenously determined investment and capital structure, in the same spirit of Leland (1994).

We find that the introduction of investment flexibility has the largest impact on credit risk among the studied features. Moreover, the more general model generates realistic distributions of firms across rating classes and realistic ranges of credit spreads, default rates, and interest rate coverage.

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Arthur G. Korteweg, "The Costs of Financial Distress across Industries" (Abstract ID: 945425): 

In this paper I estimate the market's opinion of ex-ante costs of financial distress (CFD) from a structural model of the industry, using a panel dataset of monthly market values of debt and equity for 244 firms in 22 industries between 1994 and 2004. Costs of financial distress are identified from the market values and systematic risk of a company's debt and equity. The market expects costs of financial distress to be 0-11% of firm value for observed levels of leverage. In bankruptcy, the costs of distress can rise as high as 31%. Across industries, CFD are driven primarily by the potential for under-investment problems and distressed asset fire-sales, as measured by spending on research and development and the proportion of intangible assets in the firm. There is considerable empirical support for the hypothesis that firms choose a leverage ratio based on the trade-off between tax benefits and costs of financial distress. The results do not confirm the under-leverage puzzle for firms with publicly traded debt.

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Michelle J. Waite, "Abuse or Protection?" (Abstract ID: 944916):

Bankruptcy policy balances conflicting objectives of providing consumption insurance to debtors and protecting creditors. The adoption of the 2005 Bankruptcy Abuse Prevention and Consumer Protection Act shifted the balance toward creditors by raising debtors' cost of filing for bankruptcy and reducing the amount of debt that is discharged in bankruptcy. The changes will have little effect on "opportunistic" debtors, who can still use pre-bankruptcy planning shelter substantial assets in bankruptcy. But the changes are likely to harm many non-opportunistic debtors - the people whom bankruptcy law is intended to help - simply because they cannot afford the high cost of filing. A better policy approach would be to require debtors to use of portion of both their wealth and future income to make payments on their debt, which would protect non-opportunistic debtors while deterring opportunism.

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Edward I. Altman and Brent Pasternack, "Defaults and Returns in the High Yield Bond Market: The Year 2005 in Review and Market Outlook" (Abstract ID: 943326):

Dr. Altman has earned an international reputation as an expert on corporate bankruptcy, high yield bonds, distressed debt and credit risk analysis. In this article, Altman and his team provide a comprehensive review of the 2005 high yield bond market. The article provides detailed long-term analysis of the US market, as well as trends in default, bankruptcy, recovery and returns for investors. Against this historical backdrop, the article offers some guidance on expected default rates and market performance in the burgeoning high-yield distressed bond market.

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Special thanks to the folks at ssrn.com, who suggested we let people know of the following policies and procedures in respect of downloading papers from SSRN:

Anyone new to our system who clicks on the link to purchase the paper will be first asked to register their e-mail address on our system. This is something that is required before one can download. The registration is just a security feature and doesn't cost anything, nor will the e-mail address be used for any other purpose but for our system to be able to recognize the user in his use of our services.

As always, thanks to DeJohn Allen for his help in assembling this post.

© Steve Jakubowski 2007