Asset Substitution, Debt Pricing, Optimal Leverage and Maturity

Avoiding Distortion in Corporate Valuation Litigation: An Application of Discounted Cash Flow

Bankruptcy cost and capital structure: the significance of indirect cost

Capital Structure and Asset Prices: Some Effects of Bankruptcy Procedures

This is a dynamic time for insolvency law. Many jurisdictions have made or are considering reforms to their insolvency regimes. The United Kingdom has proposed a new standalone restructuring mechanism that incorporates many attributes of Chapter 11, including a cross‐class cram down and the absolute priority rule. A distinctive feature of the UK proposal is the infusion of judicial discretion permitting courts to deviate from the absolute priority rule. This discretion is not permitted in the United States. This judicial discretion addresses a key problem with the application of the absolute priority rule in the United States—it may serve as an impediment to reorganization. This impediment is exacerbated by the recent U.S. Supreme Court decision, Czyzewski v. Jevic Holding Corp., which impacts the effective use of Chapter 11 rescue tools. This article explores the absolute priority rule, the problems associated with it, and the effect of Jevic in the United States. Drawing on the UK reform proposal, I argue that the United States should implement reforms that infuse judicial discretion into the application of the absolute priority rule. Doing so will facilitate the underlying policy goal of rescuing the company in Chapter 11 and also promote a broader policy goal of rescuing the business.

Optimal Capital Structure of the Firm in the Presence of Costs of Financial Distress

1. Introduction Capital structure decisions are instrumental in everyday managerial finance (Stretcher and Johnson 2011). The principal theoretical narratives on the capital structure choice have focused on the importance of the taxes that burden the supplier of capital on personal or a corporate level (Miller and Modigliani 1961; Modigliani and Miller 1963; Miller 1977). However, the supplier of capital is not the only entity whose income is taxed. For every dollar of corporate sales, there may be a consumption on the consumer. Since this is not a on the investor, but a on the consumer, the consumption is considered to be an irrelevant topic in the capital structure debate, but only seemingly so: the consumption affects the quantity and the price of the goods that are sold and it thus affects corporate cash flows, capital budgeting and investment financing. This is the tax effect. Unless supply is perfectly elastic or demand is perfectly inelastic, the consumption ends up burdening not only the consumer but also the producer. Having been through the literature, there has not been any previous theoretical or empirical research to explore the effect of incidence and the consumption on leverage, yield spreads and agency conflicts between shareholders and creditors. In this direction, the following analysis demonstrates the negative effect of the incidence (on the producer) and the consumption on the investment and default thresholds, delaying entry and precipitating default. The incidence effect and the consumption are also shown to have a negative effect on yield spreads, agency cost of debt and the optimal leverage ratio. The impact of consumption and incidence on investment timing and financing naturally affects corporate revenues and therefore government revenue from consumption and income taxes. In this model, government revenue is studied in a real options framework and optimal policies are estimated, calculating the level of the consumption that maximizes expected government revenue from taxation. The numerical results of this analysis provide us with a new approach to the Ramsey rule on consumption taxes, associating policies with optimal rules of irreversible investment under uncertainty. We proceed with a brief literature review on the association between corporate debt and taxes. Section 3 sets up a theoretical model for our capital budgeting problem of irreversible investment. Section 4 presents numerical results on the effects of the consumption on investment timing, agency costs of debt, yield spreads and optimal leverage. Section 5 calculates expected government revenues from taxes and suggests revenue maximizing policies, based on the effect of the consumption on investment timing and financing. The final section concludes the paper. 2. An Outline of the Debt-and-Narrative Trading shields of corporate debt for bankruptcy costs: this is the main platform of the real options approach to the interaction between operating and financing decisions. Of course, this modeling idea is not fundamentally a real-options one. Laying the foundations of modern microeconomic thought on corporate finance, Miller and Modigliani (1961) and Modigliani and Miller (1963) showed that a firm could actually increase its value without affecting its operating income, implementing an appropriate choice of the capital structure mix. The optimal magnitude of debt financing depends on the effects of the shields of corporate debt and the costs of financial distress. In this framework, it is the rate on corporate income that drives the capital structure choice. This theoretical result has generated significant implications for the theory and practice of corporate finance and there has been empirical evidence to show a positive effect of corporate income on the extent of debt financing (e. …

Bond prices in a debt priority structure with absolute priority rule deviation

This paper considers general (single facility) queueing systems with exponential service times, dealing with a finite number J of distinct customer classes. Performance of the system, as measured by the vector of steady state expected sojourn times of the customer classes (the performance vector) may be controlled by adopting an appropriate preemptive priority discipline. We show that the performance space, the set of performance vectors which are achievable under some preemptive work conserving rule, is a polyhedron described by 2J − 1 (in)equalities. The special structure of this polyhedron nevertheless allows for efficient procedures to minimize any separable convex function of the performance vector. Linear objectives are shown to be minimized by absolute priority rules, thus generalizing a well known result for M/M/1 systems. We also show that each point in the performance space may be achieved by a specific randomization of at most J + 1 absolute priority rules.

The paper analyses the correlation between the various categories of strategic behaviours that may be adopted by the parties involved in a debt restructuring and the three types of priority rules that might apply: the so called “absolute priority rule” and “relative priority rule” and a rule that can be named “no priority rule”. More specifically, the article offers an overview of the literature concerning the opportunistic behaviours in a debt restructuring and reports a lack of categorisation and agreement on the meaning of the terms used to label such behaviours, revealing how this negatively affects the discussion on priority rules. Therefore, the paper aims at filling such gap, by presenting a systematic analysis of four categories of strategic behaviour: “holdout”, “holdup”, “free-riding” and “rent-seeking”. On the basis of such categorisation, the paper proceeds with an analysis of the ways in which each category of opportunistic behaviour is affected by the application of each of the “absolute priority rule”, the “relative priority rule” and the “no priority rule”.

ABSTRACTClaims ultimately awarded to shareholders of firms in reorganization were examined for a sample of 30 filings under the 1978 Bankruptcy Reform Act. We measured the amount paid to shareholders in excess of that which they would have received under the absolute priority rule and found that this amount represents, on average, 7.6% of the total awarded to all claimants. Evidence is also reported that common share values reflect a significant proportion of value ultimately received in violation of absolute priority, suggesting that deviations from the rule were expected by the equity markets.

ABSTRACTThis study shows the extent to which deviations from the absolute priority rule increase or decrease the bankruptcy emergence payoff to traded (i.e., usually junior claimants) bondholders. The data indicate that, on average, bondholders benefit, albeit slightly, from absolute priority rule (APR) violations. This paper also examines the degree to which the bond market, in the bankruptcy filing month, anticipates departures from the APR and other influences on the payoff to bondholders. In other words, we investigate the informational efficiency of the market for bankrupt bonds. Overall, despite the complex and lengthy nature of bankruptcy proceedings, the results support efficiency.

Abstract: In a dynamic capital structure model we study whether asset substitution implies agency costs when the firm initially takes the substitution option into account. Asset substitution affects earnings in two directions: volatility increases and growth rate decreases. We show that substitution implies agency costs if volatility increases enough. In this case, debt renegotiation to avoid substitution mitigates the ex ante costs. However, debt renegotiation decreases the equity holders’ ex post costs. Thus, with a modest volatility increase, debt renegotiation allows equity holders to extract concessions from creditors albeit asset substitution was not chosen for non‐renegotiable debt. Hence, debt renegotiation need not improve ex ante firm value if asset substitution is allowed for.

This paper aims to analyse the factors affecting SMEs’ capital structure decisions with a comparative analysis covering SMEs of different sizes in Turkey from 2007 to 2018. According to the study results, no significant difference is observed based on firm size. Secondly, as SMEs’ assets grow and efficiency increases, their financial debt also rises. Asset growth leads to long-term debt, while efficiency increase generates short-term borrowing. However, as profitability increases, long-term borrowing decreases. The findings show that SMEs try to meet their financing needs with internal resources, acting in alignment with the pecking order theory. Thirdly, no relationship is identified between financial debt and SMEs’ liquidity strength, risk, and asset structure. This finding likely indicates that SMEs do not act with financial stress or agency costs in mind. That is, they do not act in alignment with the trade-off theory.

The Economic Function of Underfunded Pension Plans

Convertible debt and asset substitution of multinational corporations