A nonlinear wealth transfer from shareholders to creditors around Chapter 11 filing |
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Authors: | Yuanzhi Li |
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Institution: | Department of Finance, Fox School of Business, Temple University, United States |
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Abstract: | Past literature has assumed that negative stock returns around Chapter 11 filing are solely due to new adverse information about firm value. This paper argues that there is also a nonlinear wealth transfer from shareholders to creditors causing shareholder loss. The magnitude of the wealth transfer can be quantified in a setting where equity is a call option on firm assets as in the Merton (1974) model. The wealth transfer originates from maturity shortening of the call option as a result of Chapter 11 filing. I present a parsimonious model to explain why Chapter 11 can be voluntarily filed by managers acting in the interest of shareholders with the existence of the wealth transfer. The model-predicted stock return has comparable magnitude as observed stock returns around filing, and explains the cross-sectional variation of the latter. |
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Keywords: | Chapter 11 filing Wealth transfer |
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