A structural model with Explicit Distress Articles uri icon

authors

  • VAZ ANTUNES PEREIRA CORREIA, JOSE RICARDO
  • POBLACIÓN, JAVIER

publication date

  • September 2015

start page

  • 112

end page

  • 130

volume

  • 58

International Standard Serial Number (ISSN)

  • 0378-4266

Electronic International Standard Serial Number (EISSN)

  • 1872-6372

abstract

  • We construct a model for valuing firms and corporate securities incorporating economic and financial distress. The inclusion of financial distress costs is able to explain the low debt/zero debt puzzle and to clarify the relation between earnings and financial leverage. With standard parameter values, this model generates more realistic estimates of leverage ratios, credit spreads and recovery rates relative to a standard model of direct costs of bankruptcy. It clarifies the relation between optimal leverage and debt capacity and addresses different structural model problems such as underestimating (overestimating) spreads on safe (risky) bonds and relying on unrealistic high estimates for direct costs of bankruptcy. (C) 2015 Elsevier B.V. All rights reserved.