The Information Value of Distress
93 Pages Posted: 16 Jun 2017 Last revised: 27 Jul 2022
Date Written: June 25, 2022
We propose a novel framework for investigating learning dynamics on the debt market. Observing a firm’s survival of apparently distressed periods, the market eliminates asset value estimates that are too low to be consistent with the observed survival. Therefore, the firm’s cost of debt becomes lower for given financials. Relative to a perfect information setting, the firm strategically delays default to benefit from a subsequently lower cost of debt. Default comes as a surprise, as it reveals the currently worst possible asset value as correct. The surprise effect is mitigated for debt with higher performance sensitivity and for lower ex-ante information asymmetry.
Keywords: Asymmetric Information, Learning Dynamics, Strategic Interaction, Quantitative Debt Models
JEL Classification: G24, G33, D83
Suggested Citation: Suggested Citation