When a firm is in financial distress, its shareholders and debt holders may
benefit from a debt renegotiation to avoid an inefficient bankruptcy or
liquidation. The prospect of a debt reduction through a renegotiation may,
however, induce shareholders to default even if the firm is solvent. The view
that shareholders may default for strategic rather than for solvency reasons
has proved useful in understanding, among other things, the theoretical
determinants of corporate bond spreads, dividend policies, the optimal debt
structure, and the valuation of debt and equity.
This paper asks whether the option of shareholders to default strategically
on the firm's debt explains differences in firms' equity risk across countries.
It claims that the risk of equity should be lower for firms that operate in
countries where the insolvency procedure favours debt renegotiations