Strategic Default and Equity Risk Across Countries
Posted: 23 Jul 2010 Last revised: 28 Nov 2013
Date Written: October 10, 2011
We show that the prospect of a debt renegotiation favorable to shareholders reduces the firm's equity risk. The equity beta and return volatility are lower in countries where the bankruptcy code favors debt renegotiations and for firms with more shareholder bargaining power relative to debt holders. These relations weaken as the country's insolvency procedure favors liquidations over renegotiations. In the limit, when debt contracts cannot be renegotiated, the equity risk is independent of shareholders' incentives to default strategically. We argue that these findings support the hypothesis that the threat of strategic default can reduce the firm's equity risk.
Keywords: Debt Enforcement, Strategic Default, Liquidation Costs, Equity Risk
JEL Classification: G12, G28, G33
Suggested Citation: Suggested Citation