Investment Opportunities and Bankruptcy Prediction

Abstract

A firm's mix of growth options and assets in place is an important determinant of its optimal default strategy. Our simple model shows that shareholders of a firm with valuable investment opportunities would be able/willing to wait longer before defaulting on their contractual debt obligations than shareholders of an otherwise identical firm without such opportunities. More importantly, we show empirically using a dataset of recent corporate bankruptcies that measures of investment opportunities are significantly related to bankruptcy. Augmenting existing bankruptcy prediction models by these measures improves their in-sample fit and out-of-sample forecasting ability.

Keywords: Growth options, Bankruptcy prediction, Default threhsold

JEL Classification: G33