Priority Spreading of Corporate Debt
60 Pages Posted: 23 Dec 2016 Last revised: 26 Jan 2019
Date Written: January 25, 2019
Priority spreading refers to the practice of firms increasing their reliance on secured and subordinated debt and reducing their reliance on senior debt as their credit quality deteriorates. We argue that priority spreading occurs, in part, because security provides creditors with greater protection from dilution from other creditors than covenants that prioritize payments. Consistent with this argument, we find that secured bank creditors are rarely diluted by junior creditors in distressed restructurings while senior unsecured creditors are frequently diluted, exogenous increases in asset volatility result in greater priority spreading and yields on senior and subordinated bonds converge as asset volatility increases.
Keywords: Debt Structure, Volatility, Priority, Leverage, Bankruptcy
JEL Classification: G32, G33
Suggested Citation: Suggested Citation