August 2016

The Bank as Grim Reaper: Debt Composition and Bankruptcy Thresholds

Mark Carey and Michael B. Gordy


We offer a model and evidence that private debtholders play a key role in setting the endogenous asset value threshold below which corporations declare bankruptcy. The model, in the spirit of Black and Cox (1976), implies that the recovery rate at emergence from bankruptcy on all of the firm's debt taken together is increasing in the pre-bankruptcy share of private debt in all debt. Empirical evidence supports this and other implications of the model. Indeed, debt composition has a more economically material empirical influence on recovery than all other variables we try taken together.

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Keywords: Bankruptcy, credit risk, debt default, recovery rates


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Last Update: June 19, 2020