DEBT FORGIVENESS AND STOCK PRICE REACTION OF LENDING BANKS: THEORY AND EVIDENCE FROM JAPAN

  We provide a simple model for analyzing how debt forgiveness affects the stock price of a lending bank. Our model shows that although debt forgiveness increases shareholder wealth of a bank in healthy financial condition, it decreases shareholder wealth of a bank in unhealthy financial condition. We empirically investigate the announcement effect of debt forgiveness on bank stock prices in Japanese markets. On average, lending banks experience a significant negative announcement effect with respect to debt forgiveness. Consistent with the prediction of the model, we find a negative relation between the announcement effect and the net bad loan ratio as a proxy of the unhealthiness of the financial condition of the bank.