Formal Bankruptcy: Strategic Debt Service with Senior and Junior Creditors
AbstractA crucial aspect of debt restructuring is the redistribution of value among many diverse interests, differing in priority, collateral and bargaining power. Focusing on renegotiable debt contracts in a continuous-time framework, we characterise the U.S corporate bankruptcy renegotiation (Chapter 11) in a game-theoretic framework. In formal bankruptcy, the equity holders can renegotiate with one creditor at a time. Unlike previous studies, this allows us to endogenise not only the bankruptcy threshold but also the impairment strategy. Moreover, our game-theoretic setting allows us to explicitly introduce and accommodate varying bargaining powers of claimants. First, we show that there exists a unique sequence of equilibrium restructuring plans and impairment strategies which allows us to derive simple and intuitive closed-form solutions for pricing different classes of debt. Secondly, the model provides a theoretical explanation for cases of seniority reversal. Thirdly, we derive sufficient conditions for the senior credit spread to be smaller than the junior one at all levels of the state variable.
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Bibliographic InfoPaper provided by Birkbeck, Department of Economics, Mathematics & Statistics in its series Birkbeck Working Papers in Economics and Finance with number 0411.
Date of creation: Nov 2004
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This paper has been announced in the following NEP Reports:
- NEP-ALL-2004-12-12 (All new papers)
- NEP-FIN-2004-12-12 (Finance)
- NEP-FIN-2004-12-15 (Finance)
- NEP-LAW-2004-12-12 (Law & Economics)
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