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RFS Advance Access published online on February 22, 2006
Review of Financial Studies, doi:10.1093/rfs/hhj031
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© The Author 2006. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For permissions, please email: journals.permissions@oxfordjournals.org

Article

Theory and Evidence on the Resolution of Financial Distress

David T. Brown 1 *, Brian A. Ciochetti 2, and Timothy J. Riddiough 3
1 Warrington College of Business University of Florida
2 Center for Real Estate Massachusetts Institute of Techology
3 Graduate School of Business University of Wisconsin-Madison

* To whom correspondence should be addressed.
David T. Brown, E-mail: david.brown{at}cba.ufl.edu


  Abstract

We analyze a financially distressed owner-managed project. The main results of the model are: (1) borrower default is an endogenous response to the anticipated restructuring-foreclosure outcome; (2) the lender’s restructuring-foreclosure decision depends critically on the interaction between project value and industry liquidity; and (3) the lender waits for the industry to recapitalize before selling assets obtained through foreclosure. Empirical analysis of a large sample of defaulted commercial real estate loans supports many of the model predictions, including restructuring-foreclosure outcomes that are consistent with endogenous borrower default and firesale discounts that vary depending on industry market conditions at the time of foreclosure.


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