Articles

Theory and evidence on the resolution of financial distress

D. BROWN, B. CIOCHETTI, T. RIDDIOUGH

Review of Financial Studies

2006, vol. 19, n°4, pp.1357-1397

Departments: Finance

Keywords: REAL-ESTATE; BANKRUPTCY; VALUATION; LIQUIDATION; FORECLOSURE; CRUNCH; POLICY


We analyze a financially distressed owner-managed project. The main results of the model are: (1) borrower default is an endogenous response to the anticipated restructuring-foreclosure outcome; (2) the lender's restructuring-foreclosure decision depends critically on the interaction between project value and industry liquidity; and (3) the lender waits for the industry to recapitalize before selling assets obtained through foreclosure. Empirical analysis of a large sample of defaulted commercial real estate loans supports many of the model predictions, including restructuring-foreclosure outcomes that are consistent with endogenous borrower default and firesale discounts that vary depending on industry market conditions at the time of foreclosure.


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