Skip to main content
×
×
Home

Strategic Default, Debt Structure, and Stock Returns

  • Philip Valta (a1)
Abstract

This paper theoretically and empirically investigates how debt structure and strategic interaction among shareholders and debt holders in the event of default affect expected stock returns. The model predicts that expected stock returns are higher for firms that face high debt renegotiation difficulties and that have a large fraction of secured or convertible debt. Using a large sample of publicly traded U.S. firms for the period 1985–2012, the paper presents new evidence on the link between debt structure and stock returns that is supportive of the model’s predictions.

Copyright
Corresponding author
*Corresponding author: philip.valta@unige.ch
References
Hide All
Altman, E. “Financial Ratios, Discriminant Analysis and the Prediction of Corporate Bankruptcy.” Journal of Finance, 23 (1968), 589609.
Anderson, R., and Sundaresan, S.. “The Design and Valuation of Debt Contracts.” Review of Financial Studies, 9 (1996), 3768.
Angrist, J., and Pischke, J.-S.. Mostly Harmless Econometrics: An Empiricist’s Companion. Princeton, NJ: Princeton University Press (2009).
Asquith, P.; Gertner, R.; and Scharfstein, D.. “Anatomy of Financial Distress: An Examination of Junk-Bond Issues.” Quarterly Journal of Economics, 109 (1994), 625658.
Baldwin, C. Y., and Mason, S. P.. “The Resolution of Claims in Financial Distress: The Case of Massey Ferguson.” Journal of Finance, 38 (1983), 505516.
Barclay, M., and Smith, C.. “The Priority Structure of Corporate Liabilities.” Journal of Finance, 50 (1995), 899917.
Berglöf, E., and von Thadden, E.-L.. “Short-Term versus Long-Term Interests: Capital Structure with Multiple Investors.” Quarterly Journal of Economics, 109 (1994), 10551084.
Bharath, S., and Shumway, T.. “Forecasting Default with the Merton Distance to Default Model.” Review of Financial Studies, 21 (2008), 13391369.
Bolton, P., and Scharfstein, D.. “Optimal Debt Structure and the Number of Creditors.” Journal of Political Economy, 104 (1996), 125.
Bris, A.; Welch, I.; and Zhu, N.. “The Costs of Bankruptcy: Chapter 7 Liquidation versus Chapter 11 Reorganization.” Journal of Finance, 61 (2006), 12531303.
Carhart, M. “On the Persistence in Mutual Fund Performance.” Journal of Finance, 52 (1997), 5782.
Colla, P.; Ippolito, F.; and Li, K.. “Debt Specialization.” Journal of Finance, 68 (2013), 21172141.
Davydenko, S., and Strebulaev, I.. “Strategic Actions and Credit Spreads: An Empirical Investigation.” Journal of Finance, 62 (2007), 26332671.
Fama, E., and French, K.. “The Cross-Section of Expected Stock Returns.” Journal of Finance, 47 (1992), 427465.
Fama, E., and French, K.. “Common Risk Factors in the Returns of Stocks and Bonds.” Journal of Financial Economics, 33 (1993), 356.
Fama, E., and MacBeth, J.. “Risk, Return, and Equilibrium: Empirical Tests.” Journal of Political Economy, 81 (1973), 607636.
Fan, H., and Sundaresan, S.. “Debt Valuation, Renegotiation, and Optimal Dividend Policy.” Review of Financial Studies, 13 (2000), 10571099.
Faulkender, M., and Petersen, M.. “Does the Source of Capital Affect Capital Structure?” Review of Financial Studies, 19 (2006), 4579.
Favara, G.; Schroth, E.; and Valta, P.. “Strategic Default and Equity Risk across Countries.” Journal of Finance, 67 (2012), 20512095.
Francois, P., and Morellec, E.. “Capital Structure and Asset Prices: Some Effects of Bankruptcy Procedures.” Journal of Business, 77 (2004), 387411.
Franks, J., and Torous, W.. “An Empirical Investigation of U.S. Firms in Reorganization.” Journal of Finance, 44 (1989), 747769.
Garlappi, L.; Shu, T.; and Yan, H.. “Default Risk, Shareholder Advantage, and Stock Returns.” Review of Financial Studies, 21 (2008), 27432778.
Garlappi, L., and Yan, H.. “Financial Distress and the Cross-Section of Equity Returns.” Journal of Finance, 66 (2011), 789822.
Gertner, R., and Scharfstein, D.. “A Theory of Workouts and the Effects of Reorganization Law.” Journal of Finance, 46 (1991), 11891222.
Gilson, S.; John, K.; and Lang, L.. “Troubled Debt Restructuring: An Empirical Study of Private Reorganization of Firms in Default.” Journal of Financial Economics, 27 (1990), 315353.
Hackbarth, D.; Haselmann, R.; and Schoenherr, D.. “Financial Distress, Stock Returns, and the 1978 Bankruptcy Reform Act.” Review of Financial Studies, 28 (2015), 18101847.
Hackbarth, D.; Hennessy, C.; and Leland, H.. “Can the Trade-Off Theory Explain Debt Structure?” Review of Financial Studies, 20 (2007), 13891428.
Hege, U., and Mella-Barral, P.. “Repeated Dilution of Diffusely Held Debt.” Journal of Business, 78 (2005), 737786.
Hennessy, C., and Tserlukevich, Y.. “Taxation, Agency Conflicts, and the Choice between Callable and Convertible Debt.” Journal of Economic Theory, 143 (2008), 374404.
Houston, J., and James, C.. “Bank Information Monopolies and the Mix of Private and Public Debt Claims.” Journal of Finance, 51 (1996), 18631889.
Ingersoll, J. “A Contingent-Claims Valuation of Convertible Securities.” Journal of Financial Economics, 4 (1977), 289321.
Itô, K. “Stochastic Integral.” Proceedings of the Imperial Academy Tokyo, 20 (1944), 519524.
Jensen, M., and Meckling, W.. “Theory of the Firm: Managerial Behavior, Agency Costs, and Capital Structure.” Journal of Financial Economics, 3 (1976), 305360.
Johnson, H., and Stulz, R.. “An Analysis of Secured Debt.” Journal of Financial Economics, 14 (1985), 501521.
Leeth, J., and Scott, J.. “The Incidence of Secured Debt: Evidence from the Small Business Community.” Journal of Financial and Quantitative Analysis, 24 (1989), 379394.
Lyandres, E., and Zhdanov, A.. “Convertible Debt and Investment Timing.” Journal of Corporate Finance, 24 (2014), 2137.
Mayers, D. “Why Firms Issue Convertible Bonds: The Matching of Financial and Real Investment Options.” Journal of Financial Economics, 47 (1998), 83102.
Mella-Barral, P., and Perraudin, W.. “Strategic Debt Service.” Journal of Finance, 52 (1997), 531556.
Mikkelson, W. “Convertible Debt and Security Returns.” Journal of Financial Economics, 9 (1981), 237264.
Morellec, E. “Asset Liquidity, Capital Structure, and Secured Debt.” Journal of Financial Economics, 61 (2001), 173206.
Newey, W., and West, K.. “A Simple, Positive Semi-Definite, Heteroskedasticity and Autocorrelation Consistent Covariance Matrix.” Econometrica, 55 (1987), 703708.
Pastor, L., and Stambaugh, R.. “Liquidity Risk and Expected Stock Returns.” Journal of Political Economy, 111 (2003), 642685.
Rampini, A., and Viswanathan, S.. “Collateral and Capital Structure.” Journal of Financial Economics, 109 (2013), 466492.
Rauh, J., and Sufi, A.. “Capital Structure and Debt Structure.” Review of Financial Studies, 12 (2010), 42424280.
Scott, J. “Bankruptcy, Secured Debt, and Optimal Capital Structure.” Journal of Finance, 32 (1977), 119.
Scott, J. “Bankruptcy, Secured Debt, and Optimal Capital Structure: Reply.” Journal of Finance, 34 (1979), 253260.
Smith, C., and Warner, J.. “On Financial Contracting: An Analysis of Bond Covenants.” Journal of Financial Economics, 7 (1979), 117161.
Stein, J. “Convertible Bonds as Backdoor Financing.” Journal of Financial Economics, 32 (1992), 321.
Vassalou, M., and Xing, Y.. “Default Risk in Equity Returns.” Journal of Finance, 59 (2004), 831868.
Zhang, A. “Distress Risk Premia in Expected Stock and Bond Returns.” Journal of Banking and Finance, 36 (2012), 225238.
Zmijewski, M. “Methodological Issues Related to the Estimation of Financial Distress Prediction Models.” Journal of Accounting Research, 22 (1984), 5982.
Recommend this journal

Email your librarian or administrator to recommend adding this journal to your organisation's collection.

Journal of Financial and Quantitative Analysis
  • ISSN: 0022-1090
  • EISSN: 1756-6916
  • URL: /core/journals/journal-of-financial-and-quantitative-analysis
Please enter your name
Please enter a valid email address
Who would you like to send this to? *
×

Metrics

Full text views

Total number of HTML views: 0
Total number of PDF views: 314 *
Loading metrics...

Abstract views

Total abstract views: 989 *
Loading metrics...

* Views captured on Cambridge Core between September 2016 - 23rd July 2018. This data will be updated every 24 hours.