Within this thesis, we develop and apply a comprehensive, yet tractable framework comprising 10 sequential steps for the evaluation of claims on corporations suffering from distress. While traditional industry approaches yield consistent and unbiased valuations for claims on a healthy firm’s assets, we find encumbering evidence that results may be distorted if the valuation object experiences severe financial or economic difficulties. Standard present value, multiple, or accrual based equity valuation methods are deterministic in nature and hence, fail to properly account for the elevated idiosyncratic uncertainties surrounding distress.
Initiated by Merton (1974), on the other hand, asset pricing research has suggested structural models as a theoretically superior alternative explicitly incorporating the optionality features and asymmetric payoff-profiles of limited liability claims. However, these models have been rarely adopted by industry professionals for their proclaimed complexity, lack of transparency and stylized assumptions on the valuation object’s capital structure.
Accordingly, the proposed framework aims to overcome the above shortcomings of the original Merton (1974) model and eventually allows for an intuitive, seamless pricing of multiple claims with diverse maturity and coupon profiles based on their absolute priority ranking in bankruptcy. First, we provide a thorough characterization of both economic and financial distress and accompanying (firm) characteristics based on which a framework applicability assessment can be performed. Besides, we stress a comprehensive discussion how model input parameters can be estimated reliably.
Subsequently, we perform a holistic application of the framework to the distressed German air carrier Air Berlin. Model outputs imply a current market undervaluation of common equity by 52%. While our analysis demonstrates remarkable upsides of the framework compared to traditional valuation procedures, we conclude that a separate estimation of a going concern- and a liquidation value only partially circumvents frictions associated with the computation of a distressed firm’s overall asset value. Moreover, we find that model results are highly sensitive to changes in input factors in general and the expected asset drift rate in particular, implying a considerably low robustness to estimation errors.
Inhaltsverzeichnis (Table of Contents)
- 1 Introduction
- 1.1 Problem definition
- 1.2 Delimitations
- 1.3 Structure
- 2 Methodology
- 2.1 Research design
- 2.2 Development of the framework
- 2.3 Case study
- 3 Distress and bankruptcy
- 3.1 Definition of financial and economic distress
- 3.2 Default and bankruptcy
- 3.3 Characteristics of firms in distress or bankruptcy
- 3.4 Proceedings in financial distress and bankruptcy
- 3.5 Scope of this study
- 4 Option theory
- 4.1 Nature of an option
- 4.1.1 Generic option payoffs
- 4.1.2 Put-call-parity
- 4.1.3 Bull spread option strategy
- 4.2 Option pricing theory
- 4.2.1 Black-Scholes model in continuous time
- 5 Structural models
- 5.1 Firm value as a portfolio of options
- 5.2 Contingent claim pricing
- 5.3 Probability of default and credit risk assessment
- 5.4 Extended default-claim pricing
- 6 Framework
- 6.1 Discussion of valuation approaches
- 6.1.1 Income models
- 6.1.2 Liquidation models
- 6.2 Valuation uncertainty arising from distress
- 6.2.1 Structural uncertainty
- 6.2.2 Strategic uncertainty
- 6.3 Superiority of contingent claim pricing models
- 6.4 Estimation of model input variables
- 6.4.1 Risk-free rate
- 6.4.2 Default barrier
- 6.4.3 Debt maturity
- 6.4.4 Asset value
- 6.4.5 Asset volatility
- 6.5 Presentation
- 7 Case study
- 7.1 Company description
- 7.2 Framework applicability assessment
- 7.3 Macro and industry analysis
- 7.4 Strategic company analysis
- 7.5 Financial statement analysis
- 7.6 Capital structure analysis
- 7.7 Estimation of input variables
- 7.8 Contingent claim pricing
- 7.9 Probability of default
- 7.10 Discussion of model outputs
- 8 Limitations and future research
Zielsetzung und Themenschwerpunkte (Objectives and Key Themes)
This thesis develops and applies a framework for evaluating claims on distressed corporations. It addresses the limitations of traditional valuation methods in handling the uncertainties associated with distressed firms, proposing a structural model approach as a superior alternative. The framework aims to provide a practical and intuitive method for pricing various claims based on their bankruptcy priority.
- Evaluation of claims on distressed firms using structural models.
- Comparison of structural models with traditional valuation methods.
- Assessment of the uncertainties and complexities involved in valuing distressed assets.
- Application of the framework to a real-world case study (Air Berlin).
- Analysis of model limitations and suggestions for future research.
Zusammenfassung der Kapitel (Chapter Summaries)
1 Introduction: This chapter introduces the problem of valuing claims on distressed firms, highlighting the limitations of traditional methods and the need for a more robust approach. It outlines the thesis structure and the scope of the research.
2 Methodology: This chapter details the research design, explaining the development of the proposed framework for claim valuation. It justifies the choice of structural models over traditional methods and describes the case study approach used to evaluate the framework's effectiveness.
3 Distress and bankruptcy: This chapter provides a comprehensive definition and characterization of financial and economic distress, exploring the processes and characteristics of firms undergoing distress or bankruptcy. It clearly defines the scope of the study within the broader context of distress and insolvency.
4 Option theory: This chapter lays the theoretical foundation for the structural models used in the thesis. It introduces the core concepts of option pricing theory, including option payoffs, put-call parity, and the Black-Scholes model, providing a necessary background for understanding the subsequent chapters.
5 Structural models: This chapter delves into the theoretical framework of structural models for firm valuation. It explains how firm value can be viewed as a portfolio of options and how these models can be used for contingent claim pricing, default probability assessment, and extended default-claim pricing. This establishes the theoretical basis for the proposed valuation framework.
6 Framework: This chapter presents the core contribution of the thesis – a ten-step framework for evaluating claims on distressed firms. It compares different valuation approaches (income and liquidation models), addresses the unique uncertainties associated with distressed firms (structural and strategic uncertainties), and highlights the advantages of contingent claim pricing models. The chapter also extensively details the estimation of crucial model input variables, such as the risk-free rate, default barrier, and asset volatility.
7 Case study: This chapter applies the developed framework to Air Berlin, a distressed German airline. It includes a detailed company description, framework applicability assessment, macro and industry analysis, and a thorough financial statement and capital structure analysis. The chapter concludes with the application of contingent claim pricing and a discussion of model outputs.
8 Limitations and future research: This chapter discusses the limitations of the developed framework and suggests avenues for future research to enhance its robustness and applicability.
Schlüsselwörter (Keywords)
Distressed firms, claim valuation, structural models, option pricing, contingent claim pricing, bankruptcy, default probability, Air Berlin, financial distress, economic distress, asset valuation, risk management.
Frequently Asked Questions: A Comprehensive Framework for Evaluating Claims on Distressed Corporations
What is the main topic of this thesis?
This thesis develops and applies a novel framework for evaluating claims on financially distressed corporations. It focuses on addressing the limitations of traditional valuation methods when dealing with the uncertainties inherent in distressed firms, proposing a superior structural model approach. The framework aims to provide a practical method for pricing claims based on their bankruptcy priority.
What methodologies are used in this research?
The research employs a mixed-methods approach. It uses a structural model approach rooted in option pricing theory, comparing it to traditional valuation methods. A case study of Air Berlin is conducted to demonstrate the framework's practical application. The research design involves developing a framework, testing it against a real-world example, and analyzing the results.
What are the key themes explored in this thesis?
Key themes include the evaluation of claims on distressed firms using structural models, a comparison of structural models with traditional valuation methods, an assessment of uncertainties in valuing distressed assets, the application of the framework to a real-world case study (Air Berlin), and an analysis of model limitations and suggestions for future research. The limitations of traditional income and liquidation models in handling the complexities of distressed firms are central.
What are structural models and how are they applied in this context?
Structural models view a firm's value as a portfolio of options. This thesis utilizes these models for contingent claim pricing, assessing default probabilities, and providing extended default-claim pricing. The framework leverages this approach to overcome the shortcomings of traditional methods in valuing distressed assets, offering a more accurate and nuanced valuation.
What is the significance of the Air Berlin case study?
The Air Berlin case study serves as a real-world application of the developed framework. It demonstrates the practical utility of the structural model approach in valuing claims on a distressed corporation. The case study involves detailed financial statement analysis, capital structure analysis, and the estimation of key model input variables, culminating in a probability of default calculation.
What are the limitations of the proposed framework, and what future research is suggested?
The thesis acknowledges limitations of the framework and suggests avenues for future research. These may include exploring more sophisticated models, incorporating additional factors influencing firm valuation, and testing the framework's robustness across a wider range of industries and economic conditions. The limitations are discussed in detail in the final chapter.
What are the key input variables used in the contingent claim pricing model?
Key input variables include the risk-free rate, the default barrier (the level of asset value below which default occurs), debt maturity, asset value, and asset volatility. The thesis extensively details the estimation of these variables and their significance in determining the probability of default and claim valuations.
How does this research contribute to the field of finance?
This research contributes to the field of finance by offering a more robust and accurate method for valuing claims on distressed corporations. The developed framework addresses the limitations of traditional methods, offering a practical tool for financial analysts, investors, and stakeholders involved in distressed debt transactions. The use of structural models and the detailed case study provide valuable insights into this complex area.
What are the key differences between traditional valuation methods and the structural model approach?
Traditional valuation methods, such as income and liquidation models, often struggle to accurately capture the uncertainties associated with distressed firms. The structural model approach, by considering the firm's value as a portfolio of options, directly incorporates these uncertainties, offering a more nuanced and potentially more accurate valuation, especially when dealing with the complexities of bankruptcy priority and varying claim types.
Where can I find a more detailed explanation of the framework's components?
The framework is detailed in Chapter 6. This chapter discusses different valuation approaches, addresses uncertainties related to distressed firms (structural and strategic), highlights advantages of contingent claim pricing, and provides step-by-step guidance on estimating model input variables. The chapter also includes a presentation of the overall framework and its components.
- Arbeit zitieren
- Elias Fiebig (Autor:in), Alexander Brandt (Autor:in), 2017, Evaluation of claims on distressed firms. A conceptual framework based on structural models, München, GRIN Verlag, https://www.grin.com/document/377663
