Product Market Linkages and the Spillovers from Corporate Debt Restructurings

We model the spillovers from a distressed firm’s debt restructuring to its competitors and related firms. We demonstrate that there are two channels for these spillovers: a direct channel that transmits the effect of bankruptcy on the firm’s competitiveness, and an indirect channel that transmits information about the firm. When the indirect channel is dominant, a firm’s bankruptcy pushes up its share price and pushes down its competitor’s stock price. The effect on the competitor’s debt is more subtle since the bankruptcy can raise the probability that the competitor will also enter bankruptcy. A strengthening of the direct channel tends to reverse the directions of the price responses of both the competitor’s and firm’s own stocks but may not reverse the price response of the competitor’s debt. The richness of the spillover predictions our model generates matches that of the evidence on the pricing effects of restructurings. Moreover, the predictions explain pricing effects that are inconsistent with existing explanations of the existing literature. JEL Classification Codes: G33;