Abstract
WHILE THE IMPACT of bankruptcy costs on the value of the firm has been examined in several ways,1 no one has examined it from the standpoint of debt holders.2 In this paper, a state-preference model is employed to determine whether or not bankruptcy proceedings should be initiated by creditors and the optimal timing of such proceedings. Both single-period and multi-period situations are considered. We begin by assuming that bankruptcy may be forced whenever the firm involved is unable to meet its principal or interest obligations. We then consider other conditions, (protective covenants), under which default can be triggered. By concentrating on the valuation of debt instruments in a market context, new insights are possible in an area which heretofore has lacked systematic and rigorous decision rules.
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