Conflicts in Bankruptcy and the Sequence of Debt Issues

Capital Structure and Debt Priority

“…Our assumption of the firm's immediate liquidation upon default is consistent with Chapter 7 of the US Bankruptcy Code. It is supported by the evidence reported by Bris, Ravid, and Sverdlove () that 56% of the sampled firms that filed for Chapter 7 bankruptcy had both senior and junior debts. Also note that in Ju and Ou‐Yang's () model, the firm defaults (before the debt maturity T ) the first time the expected time‐ T value of its assets becomes smaller than the debt principal P .…”

Comparison of modeling methods for Loss Given Default

“…Both percentages are available in URD. The construction of seniority index is motivated by the findings in Bris et al (2009) that many issuers only issue bonds at the same seniority class, suggesting that only incorporating percentage above may not be sufficient, as each credit holder is likely to recover less in the event of default, the larger the number of instruments held by different creditors are at the same rank. Qi and Zhao (2010) find that this variable is the most important explanatory variable of the recovery rate (or 1-LGD).…”

Debt structure, market value of firm and recovery rate

“…4 More importantly, we argue that some of the more sophisticated measures of relative seniority that have been used up to now, such as percentage of debt above or debt cushion below, cannot always properly capture a debt instrument's position in a firm's debt structure. This is because both Bris et al (2009) and Colla et al (2011) find that firms show a tendency to issue one particular type of debt disproportionately more than other types, rendering the percentage of debt above (debt cushion) less informative of the firm's debt structure, especially for the most senior (junior) class of debt instrument. This point can be illustrated via two simple examples.…”

“…We argue that the existing measures of relative debt seniority, such as the percentage of debt above and percentage below (ie, debt cushion), cannot fully capture firms' debt structures, because firms have the tendency to issue disproportionately more of one class of debt than other classes (Bris et al 2009;Colla et al 2011). 1 We therefore propose a new variable, called seniority index, to incorporate the percentage of debt both more senior than and pari passu to (ie, at the same rank as) the instrument under consideration.…”