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Strategic Debt Service

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Author Info

  • Pierre Mella-Barral
  • William R M Perraudin

Abstract

When a firm is close to bankrupcy, equity-holders may `blackmail' owners of bonds by paying less than the originally-contracted coupon payments. This paper develops simple, closed-form expressions for bond and equity values when such blackmail effects are present. Furthermore, we show that blackmail is optimal in the following sense. Without blackmail, leverage generates agency costs because value-maximizing equity-holders liquidate firms at output price levels other than the ex-ante optimum. However, if equity-holders can extract surplus from bond-holders through blackmail, they will actually choose to liquidate the firm at the ex ante optimal shut-down point.

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Bibliographic Info

Paper provided by European Science Foundation Network in Financial Markets, c/o C.E.P.R, 77 Bastwick Street, London EC1V 3PZ in its series CEPR Financial Markets Paper with number 0039.

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Date of creation: Oct 1993
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Availability: in print
Handle: RePEc:cpr:ceprfm:0039

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Related research

Keywords: Debt Service; Corporate Bonds; Agency Costs;

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