5. Conclusion
In this study, we examined corporate bankruptcy decisions in a contingent claim model. We reveal how asymmetric information about asset quality between a firm’s insiders and outsiders affects the bankruptcy choice between selling out and default, their timing, and the debt and equity values. This paper contributes to the literature on dynamic bankruptcy models, the asset sales of distressed firms, the effects of target accounting quality on M&A process, and dynamic signaling games by showing the following novel results.
Most notably, the low-cost firm can delay the sales timing to signal asset quality to outsiders. This result suggests that distressed firms can potentially avoid fire sales by delaying asset sales. In contrast to the standard results, more debt and lower asset value can accelerate the low-cost firm’s asset sales timing because they reduce the high-cost firm’s incentive to imitate the low-cost firm. When the signaling cost in asset sales is higher than the direct cost, that is, the asset value minus the face value of debt, the low-cost firm changes the bankruptcy choice from selling out to liquidation bankruptcy, which greatly lowers the firm value. In this case, debt holders suffer severe losses, although shareholders suffer limited losses. The existing literature does not report such results, and they can account for many empirical findings of how asymmetric information (e.g., low accounting quality, industry outsider’s acquisition, and intangible assets) affects the length of the sales procedure, sales prices, shareholder wealth, and creditor recovery rates.
