In the barrier model of corporate security valuation, the firm’s creditors impose an exogenous lower barrier on the firm value to protect their claim. The firm’s shareholders own a down-and-out call option on the firm value, while the creditors’ claim is enhanced by the value of a down-and-in call. The existing literature has yielded important empirical results, as the basic model has been reexamined with different estimation methods focusing on the asset value and its volatility. One of the disputed issues is whether the implied default barrier is above or below the firm’s leverage. Other issues of interest include the barrier determinants, the effect of debt maturity on the barrier, and the relationship of the barrier with the risk-neutral probability of default. Using a sample of U.S. stocks from the New York Stock Exchange (NYSE), American Stock Exchange (AMEX), and National Association of Securities Dealers Automated Quotations (NASDAQ) drawn from the Thomson-Reuters Eikon database, our paper attempts to exploit market information such as credit ratings to arrive at more accurate estimates of the model parameters. The default barrier is backed out as a solution to the nonlinear equation involving the market value of equity and the down-and-out call option.

The barrier is estimated for 20 2-digit Standard Industrial Classification (SIC) sectors including industrials, as well as banking and services. Regression methods will identify which variables explain the estimated barrier better than existing studies. Our initial results from numerical examples are encouraging and show the following: a) The implied barrier is less than in the published literature. b) The barrier can be less than leverage, even zero for some firms. c) The probability of default is less than it is in the literature. One application of the model is for deposit insurance, because the barrier for a bank with insured deposits is in the hands of the deposit insurer Federal Deposit Insurance Cooperation due to depositor preference laws. More broadly, the barrier is negatively related to the volatility of the assets of the firm, curbing the shareholders’ appetite for risk. Thus, our revisions of barrier estimates lead to a reexamination of previous findings in the literature.