The Debt Market Role of Asset Valuation Uncertainty
We collect data on ranges of hypothetical asset liquidation values disclosed in U.S. Bankruptcy Court filings. We use this historical information to construct a firm-specific measure, “RecRisk,” which captures asset recovery risk through the uncertainty surrounding asset valuations in liquidation events. We document that higher RecRisk is associated with smaller syndicated loan amounts as a percentage of available collateral, more and tighter performance covenants, and increased loan spreads for borrowers with high credit risk. High RecRisk borrowers also experience lower secondary loan market prices and reduced liquidity for loans with high credit risk. When borrowers become financially distressed, high RecRisk is further associated with declining loan prices and reduced ownership by Collateralized Loan Obligations, the dominant investors in the leveraged loan market. Overall, our results indicate that loan contract terms and prices reflect recovery risk faced by lenders. Data Availability: Data are available from the sources cited in the text. The authors can provide the RecRisk measure at the firm-year level upon request. JEL Classifications: M41; G32; G34; G12; G21; G33.