How Does Creditor’s Liquidation Decision Affect Debt and Equity Values?

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Bankruptcy and liquidation procedures are important to determine the values of equity, debt and firm. During the liquidation process, the creditors play an important role as well as borrowers. This paper models the creditors’ liquidation decision and examines its effects on the equity and debt values and credit premiums of risky debt. If the liquidation costs are considerable, the debtholders tend to delay liquidation and it provides the equityholders with an opportunity to behave strategically. Without Chapter 11 of the U.S. Bankruptcy Code, the bankruptcy does not lead to immediate liquidation due to the costly liquidation. Additionally, we address that the tax benefit, in addition to liquidation costs, is one of the factors that cause the strategic debt service. Our model incorporates the equityholders’ bankruptcy decision and debtholders’ liquidation decision. We suggest how to determine the equity and debt values numerically using finite difference methods. And we show that Leland (1994) model is a special case of ours. Finally, this paper also examines the determinants of values of equity, debt, firm and risky debt’s credit premium.
Korean Finance Association
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Proceedings of Korean Finance Association.

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KGSF-Conference Papers(학술회의논문)
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