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Optimal capital structure and bankruptcy cascades

Author

Listed:
  • Michi Nishihara

    (Graduate School of Economics, Osaka University)

  • Takashi Shibata

    (Graduate School of Management,Tokyo Metropolitan University)

Abstract
We examine two firms'strategic choices of capital structure in the presence of negative bankruptcy spillovers.The low-profitability firm(denoted by firm L) that bankrupts earlier affects the high-profitability firm(denoted by firm H). Against negative bankruptcy spillovers, firm H takes either of the two contrasting responses:decreasing leverage to prepare for operations in the worse cash flow scenario after firm L's bankruptcy or increasing leverage to bankrupt simultaneously with firm L. Firm H takes the simultaneous bankruptcy strategy when the tax benets of increased debt dominate the cash fiows from operations after firm L's bankruptcy.With more negative bankruptcy spillovers,a smaller protability difference, and lower volatility,firm H is more likely to choose the simultaneous bankruptcy strategy.The simultaneous bankruptcy equilibrium shows a novel mechanism of bankruptcy cascades through firms'strategic choices of capital structure with negative bankruptcy spillovers. This mechanism can potentially explain the empirical findings of bankruptcy contagion and herding behavior for corporate financial policies.

Suggested Citation

  • Michi Nishihara & Takashi Shibata, 2020. "Optimal capital structure and bankruptcy cascades," Discussion Papers in Economics and Business 20-10, Osaka University, Graduate School of Economics.
    • Handle: RePEc:osk:wpaper:2010
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    File URL: http://www2.econ.osaka-u.ac.jp/econ_society/dp/2010.pdf
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    References listed on IDEAS

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    More about this item

    Keywords

    capital structure; bankruptcyspillovers; contagion; herding; realoptions;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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