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The Importance of Incomplete Information in Explaining the Existence of Costly Bankruptcy

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Author Info
Webb, David C

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Abstract

The standard theory of capital structure argues that firms trade off the tax advantage of debt against ba nkruptcy costs. R. A. Haugen and L. W. Senbet (1978) pointed out that there is a problem with this theory: if bankruptcy involves deadweig ht costs, shareholders and bondholders have an incentive to renegotia te before it occurs since in this way bankruptcy, and its costs, can be avoided. This implies costly bankruptcy will not occur and casts d oubt on the validity of the standard theory. This paper uses noncoope rative bargaining theory to formally model this idea. It then shows t hat if there is incomplete information, costly bankruptcy can occur. Copyright 1987 by The Review of Economic Studies Limited.

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Publisher Info
Article provided by London School of Economics and Political Science in its journal Economica.

Volume (Year): 54 (1987)
Issue (Month): 215 (August)
Pages: 279-88
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Handle: RePEc:bla:econom:v:54:y:1987:i:215:p:279-88

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  1. Régis Blazy & Laurent Weill, 2007. "The Impact of Legal Sanctions on Moral Hazard when Debt Contracts are Renegotiable," Working Papers DULBEA 07-06.RS, Université libre de Bruxelles, Department of Applied Economics (DULBEA). [Downloadable!]
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  2. Régis Blazy & Gisèle Umbhauer & Laurent Weill, 2008. "How Bankruptcy Punishment Influences the Ex-Ante Design of Debt Contracts?," Working Papers of CREFI-LSF (Centre of Research in Finance - Luxembourg School of Finance) 08-04, CREFI-LSF, University of Luxembourg. [Downloadable!]
  3. Ying Yan, 1996. "Credit Rationing, Bankruptcy Cost, and Optimal Debt Contract for Small Business," Finance 9612003, EconWPA. [Downloadable!]
  4. Ying Yan, 1997. "Credit rationing, bankruptcy cost, and the optimal debt contract for small business," Working Paper 9702, Federal Reserve Bank of Cleveland. [Downloadable!]
  5. Michelle J. White, 2005. "Economic Analysis of Corporate and Personal Bankruptcy Law," NBER Working Papers 11536, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  6. Jocelyn Martel, 1991. "Bankruptcy Law and the Canadian Experience: An Economic Appraisal," Canadian Public Policy, University of Toronto Press, vol. 17(1), pages 52-63, March. [Downloadable!] (restricted)
  7. Jocelyn Martel, 1996. "Solutions au stress financier : Un survol de la littérature," CIRANO Working Papers 96s-03, CIRANO. [Downloadable!]
  8. Philippe Frouté, 2007. "Theoretical foundation for a debtor friendly bankruptcy law in favour of creditors," European Journal of Law and Economics, Springer, vol. 24(3), pages 201-214, December. [Downloadable!] (restricted)
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