Theory and Evidence on the Resolution of Financial Distress

41 Pages Posted: 21 Jun 2003

See all articles by David T. Brown

David T. Brown

University of Florida - Department of Finance, Insurance and Real Estate

Brian A. Ciochetti

Independent

Timothy J. Riddiough

University of Wisconsin - School of Business - Department of Real Estate and Urban Land Economics

Multiple version iconThere are 2 versions of this paper

Date Written: April 2003

Abstract

This paper models financial distress of an owner-managed project. As a result of a negative shock to project value, financial distress occurs in three stages: default-no-default, reorganization-foreclose, sell the foreclosed asset immediately-delay the asset sale. Factors that impact equilibrium outcomes include the severity of the shock to project fundementals, the quality of asset management, and the liquidity of outside investors. Borrower default is endogenous in our model, in the sense that the anticipated outcome of default can determine whether or not default occurs in the first place. Model predictions include that the reorganization-foreclosure decision depends crucially on the interaction between project value and industry liquidity and that the lender waits for the industry to recapitalize before selling assets obtained through foreclosure. An empirical analysis of a large sample of defaulted commercial real estate loans supports many of the predictions of the model, including the existence of endogenous borrower default, significant underinvestment on foreclosed assets, and delayed asset sales in response to weak industry conditions.

Suggested Citation

Brown, David T. and Ciochetti, Brian A. and Riddiough, Timothy J., Theory and Evidence on the Resolution of Financial Distress (April 2003). Available at SSRN: https://ssrn.com/abstract=407020 or http://dx.doi.org/10.2139/ssrn.407020

David T. Brown (Contact Author)

University of Florida - Department of Finance, Insurance and Real Estate ( email )

P.O. Box 117168
Gainesville, FL 32611
United States
352-392-2820 (Phone)
352-392-0301 (Fax)

Brian A. Ciochetti

Independent

Timothy J. Riddiough

University of Wisconsin - School of Business - Department of Real Estate and Urban Land Economics ( email )

School of Business
975 University Avenue
Madison, WI 53706
United States
608-262-3531 (Phone)
608-265-2738 (Fax)

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