Default Prone Bond Prices, Valuable Growth Options and the Option to Re-Organize

22 Pages Posted: 16 Jun 2010

See all articles by Osman Colak

Osman Colak

Commerzbank AG

Padma Kadiyala

Pace University - Lubin School of Business

Date Written: January 15, 2007

Abstract

There is a wide body of literature in corporate finance that examines the tradeoffs between liquidation and re-organization for creditors in financially distressed firms (Kahl (2002), Hotchkiss (1995), Gertner and Scharfstein (1991)). We incorporate salient elements from this literature into a structural model of corporate bond prices. We derive the value of perpetual coupon-paying risky debt as a function of the option held by bondholders to either liquidate or to take control when a firm becomes financially distressed. Liquidation value is the depreciated value of assets in place. Firm value under bondholders is with some efficiency loss, the sum of assets in place and future growth options. We derive ex-ante values of corporate bond prices as a function of the current values of these two competing choices.

Keywords: Corporate bond pricing, contingent claim pricing, bankruptcy, growth options

JEL Classification: G12, G13, G32, G33

Suggested Citation

Colak, Osman and Kadiyala, Padma, Default Prone Bond Prices, Valuable Growth Options and the Option to Re-Organize (January 15, 2007). Pace University Finance Research Paper No. 2010/05, Available at SSRN: https://ssrn.com/abstract=1625480 or http://dx.doi.org/10.2139/ssrn.1625480

Osman Colak (Contact Author)

Commerzbank AG ( email )

Germany

Padma Kadiyala

Pace University - Lubin School of Business ( email )

1 Pace Plaza
New York, NY 10038-1502
United States
914-773-3620 (Phone)

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