Business Cycles and the Bankruptcy Code: A Structural Approach

62 Pages Posted: 13 Apr 2010 Last revised: 2 Jun 2011

See all articles by Redouane Elkamhi

Redouane Elkamhi

University of Toronto - Rotman School of Management

Min Jiang

University of Iowa - Henry B. Tippie College of Business

Date Written: January 15, 2010

Abstract

We develop a structural equilibrium model with business cycles and use it to examine the economic implications of voluntary filing for bankruptcy. We find that conflict of interests that arises from the voluntary filing option of Chapter 11 causes higher ex-ante losses in firm value in recessions than in booms. These costs amount to approximately 5% of the ex-ante value for a BAA-rated representative firm and are twice as large as those produced by a model that does not allow for business cycle fluctuations. We relate these economic costs to firm fundamentals and to long-run economic uncertainty. We also show that in addition to macroeconomic conditions and liquidation costs, countercyclical distress costs and conflict of interests between debtors and creditors help to simultaneously generate reasonable credit spreads, levered equity premium and leverage ratios. Our framework nests a number of important models in the literature and we provide closed-form solutions for the equity, debt and levered asset values.

Keywords: credit risk, macroeconomic conditions, bankruptcy, Chapter 11

JEL Classification: E44, G12, G13, G32, G33

Suggested Citation

Elkamhi, Redouane and Jiang, Min, Business Cycles and the Bankruptcy Code: A Structural Approach (January 15, 2010). AFA 2012 Chicago Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1586494 or http://dx.doi.org/10.2139/ssrn.1586494

Redouane Elkamhi

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada

Min Jiang (Contact Author)

University of Iowa - Henry B. Tippie College of Business ( email )

Acquisitions
5020 Main Library
Iowa City, IA 52242-1000
United States

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