The Journal of Finance Forthcoming Article Abstract

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Abstract:
Do bankrupt firms impose negative externalities on their non-bankrupt competitors? We propose and analyze a collateral channel in which a firm’s bankruptcy reduces collateral values of other industry participants, thereby increasing their cost of external debt finance. To identify this collateral channel, we use a novel dataset of secured debt tranches issued by U.S. airlines which includes a detailed description of the underlying assets serving as collateral. Our estimates suggest that industry bankruptcies have a sizeable impact on the cost of debt financing of other industry participants. We discuss how the collateral channel may lead to contagion effects which amplify the business cycle during industry downturns.