Strategic default and equity risk across countries

We test whether the firm’s systematic equity risk reflects the shareholders’ incentives to default strategically on the firm’s debt. We use a real options model to relate the shareholders’ strategic default behavior to frictions in the debt renegotiation procedure. We test the model’s predictions with an international cross-section of stocks, exploiting the exogenous cross-country variation of bankruptcy procedures. We find that the equity beta increases as debt is more strictly enforced. Moreover, the equity beta decreases with liquidation costs and shareholders’ bargaining power, and the sensitivity of this relation weakens as the country’s debt renegotiation procedures become more creditor friendly.