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The dynamics of default and debt reorganization

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  • Mella-Barral, Pierre

Abstract

This article documents the fact that when debtors decide to default on their obligations too early, it is in the creditors' collective interest, as residual claimants, to make concessions prior to forcing a costly liquidation. Symmetrically, when debtors prefer to default at an inefficiently late stage, it is in the creditors' interest to propose a departure from the absolute priority rule. This article develops a continuous time pricing model of dynamic debt restructuring that reflects the crucial influence of the two counterparties' relative bargaining power. Simple and intuitive path-dependent pricing formulae are derived for equity and debt. The debt capacity as well as the evolution of the firm's capital structure throughout its existence is provided.

Suggested Citation

  • Mella-Barral, Pierre, 1996. "The dynamics of default and debt reorganization," LSE Research Online Documents on Economics 119173, London School of Economics and Political Science, LSE Library.
    • Handle: RePEc:ehl:lserod:119173
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    File URL: http://eprints.lse.ac.uk/119173/
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    References listed on IDEAS

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    More about this item

    JEL classification:

    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • G20 - Financial Economics - - Financial Institutions and Services - - - General

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