Explaining Debt Recovery Using an Endogenous Bankruptcy Model

Abstract

Drawing on a large sample of defaulted corporate debt from 1996 to 2007, the authors find that the debt recovery estimated using the Leland–Toft endogenous bankruptcy model has strong explanatory power on the debt recovery observed in the market. Their results hold after firm characteristics, industry distress, and macroeconomic conditions are taken into account. In addition, they find that both agency problems and heterogeneous bankruptcy costs weaken the explanatory power of the model. The study suggests that structural models that incorporate the role of managers in endogenously determining the bankruptcy boundary provide statistical power in explaining the cross-sectional variation of corporate debt recovery.