Creditor Coordination Effects and Distress Prediction

Abstract

Prior research and recent anecdotes during the financial crisis demonstrate that lack of creditor coordination can exacerbate distress thereby illustrating the economic importance of creditor coordination effects. This study develops and incorporates empirical ex ante measures, or predictors, of creditor coordination effects in distress prediction. Using a comprehensive distress dataset, I find that empirical ex ante measures of creditor coordination effects (CCE) are robust incremental predictors of distress. I further find that CCE substantially improves the prediction accuracy of hazard rate models (e.g., by 10 percent, on average, for private firm models), which suggests that the explanatory power of CCE is economically meaningful. Additional tests that explore the link between CCE and ex post creditor coordination failures are consistent with CCE predicting distress caused by coordination failure among creditors, and inconsistent with these effects explaining other sources of distress. The results of this study point towards a distinct contribution of creditor coordination effects in predicting firm distress, with greater improvements in predicting distress in incidences with a higher likelihood of creditor coordination failure, such as bankruptcies that are not pre-packaged or prearranged and defaults triggered by creditor runs.

Keywords: Distress prediction, creditor coordination, information uncertainty, transparency, earnings volatility, analyst forecast dispersion

JEL Classification: G33, M41