The Information Value of Distress

Christian Hilpert, Stefan Hirth () and Alexander Szimayer ()
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Stefan Hirth: Department of Economics and Business Economics, Aarhus University and Danish Finance Institute, 8210 Aarhus V, Denmark
Alexander Szimayer: Faculty of Business, Economics and Social Sciences, Universität Hamburg, 20146 Hamburg, Germany

Management Science, 2024, vol. 70, issue 1, 78-97

Abstract: We propose a novel framework for investigating learning dynamics on the debt market. Observing a firm’s survival of apparently distressed periods, the market eliminates asset value estimates that are too low to be consistent with the observed survival. Therefore, the firm’s cost of debt becomes lower for given financials. Relative to a perfect information setting, the firm strategically delays default to benefit from a subsequently lower cost of debt. Default comes as a surprise, as it reveals the currently worst possible asset value as correct. The surprise effect is mitigated for debt with higher performance sensitivity and for lower ex ante information asymmetry.

Keywords: asymmetric information; learning dynamics; strategic interaction; quantitative debt models (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:inm:ormnsc:v:70:y:2024:i:1:p:78-97

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