Abstract
We explore the determinants of liquidation values of assets, particularly focusing on the potential buyers of assets. When a firm in financial distress needs to sell assets, its industry peers are likely to be experiencing problems themselves, leading to asset sales at prices below value in best use. Such illiquidity makes assets cheap in bad times, and so ex ante is a significant private cost of leverage. We use this focus on asset buyers to explain variation in debt capacity across industries and over the business cycle, as well as the rise in U.S. corporate leverage in the 1980s.
Highlights
How do firms choose debt levels, and why do firms or even whole industries sometimes change how much debt they have? Why, for example, have American firms increased their leverage tremendously in the 1980s (Berrianke and Campbell 1988, Warshassky 1990), and why has this debt increase been the greatest in some industries, such as food and timber? Despite substantial progress in research on leverage, these questions remain largely open
We explore an approach to debt capacity based on the cost of asset sales
We argue that this approach helps understand the crosssectional determinants of leverage,and sheds light on the debt—increases of the 1980s
Summary
“Liquidation Values and Debt Capacity: A Market Equilibrium Approach.”. The Journal of Finance 47 (4) (September): 1343–1366.
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