Big Price Tag on Corporate Defaults (Stanford Business)

New research suggests default can cut a company’s market value by an average of 21.7%.

Defaults and bankruptcies cause a larger decline in a company’s market value than is generally realized, according to a study by three professors at Stanford University and the University of Toronto. They estimate that a default—which can range from a missed bond payment to a bankruptcy filing—reduces a company’s total market value by 21.7% on average, and cuts the value of an investment-grade company by 30%. A previous study estimated that a default costs a company around 20% of its total asset value.

Stanford’s Ilya Strebulaev has been analyzing defaults for years and has found that companies with large stores of cash are more likely to default, because executives hoard cash when they’re worried, and that companies often wait to liquidate projects until a downturn in the industry in an effort to escape notice.

This new study looked at historical data on corporate defaults and used an analytical model that examined investor reactions before and after the default, measuring both the drop in stock and bond prices right after the announcement.

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