Strategic Default and Equity Risk Across Countries

Posted: 23 Jul 2010 Last revised: 28 Nov 2013

See all articles by Giovanni Favara

Giovanni Favara

HEC University of Lausanne; Ecole Polytechnique Fédérale de Lausanne - Ecole Polytechnique Fédérale de Lausanne; International Monetary Fund (IMF)

Enrique J. Schroth

City University London - Cass Business School; Centre for Economic Policy Research (CEPR)

Philip Valta

University of Bern

Date Written: October 10, 2011

Abstract

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

Favara, Giovanni and Schroth, Enrique J. and Valta, Philip, Strategic Default and Equity Risk Across Countries (October 10, 2011). Journal of Finance, 67(6), 2012. Available at SSRN: https://ssrn.com/abstract=1646980

Giovanni Favara

HEC University of Lausanne ( email )

Unil Dorigny, Batiment Internef
Lausanne, 1015
Switzerland

HOME PAGE: http://www.hec.unil.ch/gfavara/

Ecole Polytechnique Fédérale de Lausanne - Ecole Polytechnique Fédérale de Lausanne

c/o University of Geneve
40, Bd du Pont-d'Arve
1211 Geneva, CH-6900
Switzerland

International Monetary Fund (IMF)

700 19th Street, N.W.
Washington, DC 20431
United States

Enrique J. Schroth (Contact Author)

City University London - Cass Business School ( email )

London, EC1Y 8TZ
Great Britain

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Philip Valta

University of Bern ( email )

Engehaldenstrasse 4
Bern, 3012
Switzerland

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