Marking to Market Corporate Debt

87 Pages Posted: 25 Sep 2020 Last revised: 17 Mar 2021

See all articles by Lorenzo Bretscher

Lorenzo Bretscher

London Business School - Department of Finance

Peter Feldhütter

Copenhagen Business School

Andrew Kane

Duke University, Fuqua School of Business, Students

Lukas Schmid

University of Southern California - Marshall School of Business

Date Written: September 17, 2020

Abstract

Models of capital structure and credit risk make predictions about market valuations of debt, but are routinely tested on the basis of book debt from common data sources. In this paper, we propose to close this gap. We construct a rich data set on firm level debt market valuations by carefully matching data on corporate bond and loan secondary market transactions. We document significant discrepancies between market and book values, especially for distressed firms. We use our dataset to i) provide novel rules of thumb on how to adjust leverage and unlever returns using standard datasets, and ii) to revisit a number of prominent empirical patterns involving corporate debt. Using a market-based measure of Tobin's Q, we find little evidence for investment cash-flow sensitivity in our data. We find that using market debt values significantly improves default prediction, and do not detect a credit spread puzzle. In asset pricing tests, we find a leverage premium, but no evidence for a value premium after controlling for market leverage. Moreover, a novel measure of financial distress, namely market-to-book debt, predicts stock returns positively in the cross-section, inconsistent with a financial distress puzzle.

Keywords: Corporate Debt Valuations, Tobin's Q, Leverage Premium

Suggested Citation

Bretscher, Lorenzo and Feldhütter, Peter and Kane, Andrew and Schmid, Lukas, Marking to Market Corporate Debt (September 17, 2020). Swiss Finance Institute Research Paper No. 21-06, USC Marshall School of Business Research Paper Sponsored by iORB, No. Forthcoming, Available at SSRN: https://ssrn.com/abstract=3681817 or http://dx.doi.org/10.2139/ssrn.3681817

Lorenzo Bretscher (Contact Author)

London Business School - Department of Finance ( email )

Sussex Place
Regent's Park
London NW1 4SA
United Kingdom

Peter Feldhütter

Copenhagen Business School ( email )

Solbjerg Plads 3
Frederiksberg C, DK - 2000
Denmark

Andrew Kane

Duke University, Fuqua School of Business, Students ( email )

Durham, NC
United States

Lukas Schmid

University of Southern California - Marshall School of Business ( email )

701 Exposition Blvd, HOH 431
Los Angeles, CA California 90089-1424
United States

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