The Information Value of Distress

TY - JOUR

T1 - The Information Value of Distress

AU - Hilpert, Christian

AU - Hirth, Stefan

AU - Szimayer, Alexander

PY - 2024/1

Y1 - 2024/1

N2 - We propose a novel framework for investigating learning dynamics on the debt market. Observing a firm’s survival of apparently distressed periods, the market eliminates asset value estimates that are too low to be consistent with the observed survival. Therefore, the firm’s cost of debt becomes lower for given financials. Relative to a perfect information setting, the firm strategically delays default to benefit from a subsequently lower cost of debt. Default comes as a surprise, as it reveals the currently worst possible asset value as correct. The surprise effect is mitigated for debt with higher performance sensitivity and for lower ex ante information asymmetry.

AB - We propose a novel framework for investigating learning dynamics on the debt market. Observing a firm’s survival of apparently distressed periods, the market eliminates asset value estimates that are too low to be consistent with the observed survival. Therefore, the firm’s cost of debt becomes lower for given financials. Relative to a perfect information setting, the firm strategically delays default to benefit from a subsequently lower cost of debt. Default comes as a surprise, as it reveals the currently worst possible asset value as correct. The surprise effect is mitigated for debt with higher performance sensitivity and for lower ex ante information asymmetry.

KW - asymmetric information

KW - learning dynamics

KW - quantitative debt models

KW - strategic interaction

UR - http://www.scopus.com/inward/record.url?scp=85182263511&partnerID=8YFLogxK

U2 - 10.1287/mnsc.2022.4632

DO - 10.1287/mnsc.2022.4632

M3 - Journal article

SN - 0025-1909

VL - 70

SP - 78

EP - 97

JO - Management Science

JF - Management Science

IS - 1

ER -