Capital Structure and Real Assets: Effects of an Implicit Collateral to Debt Holders

This paper analyzes how real assets implicitly provide a collateral for debt when an initially profitable production becomes relatively non-profitable in a structural model framework. Ex ante, the implicit collateral will benefit the firm owners because the tax shield can be better exploited. Results indicate that the firm value can increase by 40-50% and the par yield may decrease about 200 bps. The possibility to sell the assets extends the equity holders' strategy space: entering a renegotiation process with the debt holders may lead to either a restructuring of the firm's capital or an asset sale. The model further provides an argument for why Internet firms lose value fast when the initial production fails to be profitable.