The Bank as Grim Reaper: Debt Composition and Recoveries on Defaulted Debt Mark Carey & Michael B. Gordy ∗ Board of Governors of the Federal Reserve System July 25, 2007 Abstract We offer a model and evidence that private debtholders play a key role in setting the endogenous asset value threshold below which corporations declare bankruptcy. The model, in the spirit of Black and Cox (1976), implies that the recovery rate at emergence from bankruptcy on all of the firm’s debt is related to the pre-bankruptcy share of private debt in all of the firm’s debt. Empirical evidence supports this implication. Indeed, debt composition has a more economically material empirical influence on recovery than all other variables we try taken together. This special role of private debt in the capital structure has important implications for pricing models and risk management. Keywords: credit risk, recovery rates, bankruptcy, debt default JEL Codes: G12, G33, G32 ∗ This paper represents the authors’ opinions and not necessarily those of the Board of Gover- nors, the Federal Reserve System, or other members of its staff. We thank Viral Acharya, Jim Booth, Richard Cantor, Jens Christensen, Michel Crouhy, Magnus Dahlquist, Sanjiv Das, Sergei Davydenko, Darrell Duffie, Klaus Dullman, Edie Hotchkiss, David Keisman, Kasper Roszbach, Per Stromberg, Hao Zhou and participants at several seminars and conference sessions for encour- agement and suggestions, and Bradley Howells and Matthew Cox for excellent research assistance. Much of this research was completed while M. Gordy was a visitor at the Indian School of Business. Email: 〈mark.carey@frb.gov〉 and 〈michael.gordy@frb.gov〉.