Bankruptcy, absolute priority, and the pricing of risky debt claims

In practice, there are substantial deviations from the doctrine of ‘absolute priority’, which governs the rights of the firm's claimholders in the event of bankruptcy. To determine whether or not the possibility of such deviations is reflected in the prices of the firm's securities, this s...

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Bibliographic Details
Published in:Journal of financial economics 1977-05, Vol.4 (3), p.239-276
Main Author: Warner, Jerold B.
Format: Article
Language:English
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Summary:In practice, there are substantial deviations from the doctrine of ‘absolute priority’, which governs the rights of the firm's claimholders in the event of bankruptcy. To determine whether or not the possibility of such deviations is reflected in the prices of the firm's securities, this study examines the risk and return characteristics of financial claims against firms in court-supervised bankruptcy proceedings. Debt claims against bankrupt firms are indeed ‘risky’, exhibiting levels of systematic risk similar to that of common stocks in general. While some of the findings are anomalous, the data are generally consistent with the view that the capital market ‘properly’ prices risky debt claims to reflect both their risk characteristics and the possibility of departures from the doctrine of absolute priority.
ISSN:0304-405X
1879-2774
DOI:10.1016/0304-405X(77)90002-2