Do Specialized Distress Investors Undermine Firms Ex Ante?
62 Pages Posted: 31 Mar 2023 Last revised: 14 Dec 2024
Date Written: December 14, 2024
Abstract
We extend the canonical moral hazard model in corporate finance to include specialized distress investors (SDIs); and characterize how potential SDI entry affects credit rationing and project NPV ex ante. In the model, SDIs can cause negative spillovers even when adding value ex post, and conversely, SDIs that destroy value ex post may still prove beneficial ex ante. Furthermore, we demonstrate how firms can strategically influence the likelihood of SDI entry through project selection and choice of capital structure. Our work broadens our understanding of SDIs' role in corporate finance, by studying ex ante effects.
Keywords: distressed debt investors, vulture investors, financial distress, moral hazard, incomplete contracts, banking, reputation, bailouts
JEL Classification: G21, G23, G32, G33
Suggested Citation: Suggested Citation