Liquidation Triggers and the Valuation of Equity and Debt

Dan Galai, Alon Raviv () and Zvi Wiener ()
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Dan Galai: The Hebrew University Business school

Finance from EconWPA

Abstract: Net-worth covenants, as introduced by Black and Cox (1976), provide the firm’s bondholders with the right to force reorganization or liquidation if the value of the firm falls below a certain threshold. In the event of default, however, many bankruptcy codes stipulate an automatic stay of assets that prevent bondholders from triggering liquidation and thus impact many positive net-worth covenants. To consider this impact on a corporation’s capital structure we develop a general model of liquidation driven by a liquidation trigger. This trigger accumulates with time and severity of distress. In addition, current distress periods may have greater weight than old ones. The tractability of the approach stems from its ability to allow parameters appropriate for different legal rules and types of bondholder safety covenants. The proposed model includes several well-known models, like Merton, Black- Cox and others. We show how to valuate various types of corporate securities by using this model. Numerical results and sensitivity analysis are presented for selected basic cases.

Keywords: default; bankruptcy; liquidation trigger; debt pricing; corporate finance (search for similar items in EconPapers)
JEL-codes: G12 G32 G33 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cfn
Date: 2003-05-14
Note: Type of Document - ; prepared on IBM PC ; to print on HP/;
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Journal Article: Liquidation triggers and the valuation of equity and debt (2007)
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Persistent link: http://EconPapers.repec.org/RePEc:wpa:wuwpfi:0305002

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