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Strategic Default and Equity Risk Across Countries





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    • Favara is with the International Monetary Fund. Schroth is with the University of Amsterdam. Valta is with HEC Paris. The authors thank Viral Acharya, Albert Chun, Stijn Claessens, Engelbert Dockner, Laurent Frésard, Erasmo Giambona, Ron Giammarino, Amit Goyal, Nishad Kapadia, Ernst Maug, Erwan Morellec, Stefano Rossi, Ilya Strebulaev, René Stulz, Kenichi Ueda, Andrea Vedolin, Elu Von Thadden, an anonymous referee, the Advisory Editor, and Cam Harvey (the Editor) for valuable suggestions that improved the paper. The authors also thank seminar participants at Cass Business School, the University of Mannheim, the 2010 WFA Meeting (Victoria), the 2010 FIRS Meeting (Florence), the 2009 EFA Meeting (Bergen), and the 2008 Swiss Doctoral Workshop (Gerzensee). The views expressed in this paper are those of the authors, and should not be attributed to the IMF, its Executive Board, or its management.


We show that the prospect of a debt renegotiation favorable to shareholders reduces the firm's equity risk. Equity beta and return volatility are lower in countries where the bankruptcy code favors debt renegotiations and for firms with more shareholder bargaining power relative to debt holders. These relations weaken as the country's insolvency procedure favors liquidations over renegotiations. In the limit, when debt contracts cannot be renegotiated, equity risk is independent of shareholders' incentives to default strategically. We argue that these findings support the hypothesis that the threat of strategic default can reduce the firm's equity risk.