Informational Role of Investment in Bankruptcy

We develop a credit-risk model to study the informational role of investment in bankruptcy. Firms' investment decisions carry information about their asset quality, thereby mitigating informational frictions when firms enter bankruptcy. An increase in aggregate investment can reduce the informational value of investment, depressing firms' recovery values. Therefore, policies boosting investment can decrease debt and firm values through reducing the informational value of investment. The presence of debt overhang may enhance firm value by making firms' investment decisions more informative. We present suggestive empirical evidence consistent with model predictions on the relation between firms' investment rates and recovery rates