Cash-Flow Shortage as an Endogenous Bankruptcy Reason
Posted: 1 Apr 2005
Abstract
This paper develops a simple model for a leveraged firm and endogenizes the firm's bankruptcy point by assuming that equity issuance is costly. Equity-issuance costs reflect the difficulties in issuing new equity for firms that are close to financial distress. The resulting model captures cash-flow shortage as a reason to go bankrupt, though the equity value is positive. I analyze the optimal bankruptcy point as well as corporate bond prices and yield spreads for various levels of equity-issuance costs in order to study the impact of different liquidity constraints. Finally, I discuss the consequences on optimal capital structure.
Keywords: Continuous-time bankruptcy model, corporate bond pricing, credit spreads, equity finance costs, optimal capital structure
JEL Classification: G13, G32, G33
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