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Co-ordination failure and the role of banks in the resolution of financial distress

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  • Spyros Pagratis
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    Abstract

    This article discusses the out-of-court restructuring of the contractual obligations of a financially distressed firm, under conditions of asymmetric information among the firm’s creditors and in situations where a creditor bank makes concessions conditional on other creditors’ actions. I show that a bank’s conditional commitment to support the financially distressed firm may inject a degree of strategic solidity among other creditors and reduce the deadweight costs of inefficient liquidation. However, should a bank’s concession be made conditional on a high tendering rate by other creditors, this may negate the positive information externality of bank’s action. Low minimum tendering rates, on the other hand, may lead to multiple equilibria in creditors’ strategies; but, all those equilibria are shown to be Pareto improving of the unique equilibrium when there is no bank in the game.

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    File URL: http://eprints.lse.ac.uk/24939/
    File Function: Open access version.
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    Bibliographic Info

    Paper provided by London School of Economics and Political Science, LSE Library in its series LSE Research Online Documents on Economics with number 24939.

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    Length: 32 pages
    Date of creation: 16 Feb 2004
    Date of revision:
    Handle: RePEc:ehl:lserod:24939

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    Postal: LSE Library Portugal Street London, WC2A 2HD, U.K.
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    Web page: http://www.lse.ac.uk/
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    Related research

    Keywords: Financial distress; Tender offers; Global games;

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    References

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    1. Fama, Eugene F., 1985. "What's different about banks?," Journal of Monetary Economics, Elsevier, vol. 15(1), pages 29-39, January.
    2. Hans Carlsson & Eric van Damme, 1993. "Global Games and Equilibrium Selection," Levine's Working Paper Archive 122247000000001088, David K. Levine.
    3. Morris, Stephen & Shin, Hyun Song, 1997. "Unique Equilibrium in a Model of Self-fulfilling Currency Attacks," CEPR Discussion Papers 1687, C.E.P.R. Discussion Papers.
    4. Morris, Stephen & Shin, Hyun Song, 1999. "Risk Management with Interdependent Choice," Oxford Review of Economic Policy, Oxford University Press, vol. 15(3), pages 52-62, Autumn.
    5. James, Christopher, 1995. "When Do Banks Take Equity in Debt Restructurings?," Review of Financial Studies, Society for Financial Studies, vol. 8(4), pages 1209-34.
    6. Giammarino, Ronald M, 1989. "The Resolution of Financial Distress," Review of Financial Studies, Society for Financial Studies, vol. 2(1), pages 25-47.
    7. Hyun Song Shin & Stephen Morris, 2001. "Coordination Risk and the Price of Debt," FMG Discussion Papers dp373, Financial Markets Group.
    8. Morris, Stephen, 1995. "The Common Prior Assumption in Economic Theory," Economics and Philosophy, Cambridge University Press, vol. 11(02), pages 227-253, October.
    9. Gilson, Stuart C. & John, Kose & Lang, Larry H. P., 1990. "Troubled debt restructurings*1: An empirical study of private reorganization of firms in default," Journal of Financial Economics, Elsevier, vol. 27(2), pages 315-353, October.
    10. Hyun Shin, 2001. "Coordination Risk and the Price of Debt," Economics Series Working Papers 1999-W25, University of Oxford, Department of Economics.
    11. Vives, Xavier, 1990. "Nash equilibrium with strategic complementarities," Journal of Mathematical Economics, Elsevier, vol. 19(3), pages 305-321.
    12. Stephen Morris & Hyun Song Shin, 2001. "Coordination risk and the price of debt," LSE Research Online Documents on Economics 25046, London School of Economics and Political Science, LSE Library.
    13. White, Michelle J, 1989. "The Corporate Bankruptcy Decision," Journal of Economic Perspectives, American Economic Association, vol. 3(2), pages 129-51, Spring.
    14. Mitchell Berlin & Kose John & Anthony Saunders, 1995. "Bank equity stakes in borrowing firms and financial distress," Working Papers 96-1, Federal Reserve Bank of Philadelphia.
    15. Stephen Morris & Hyun Song Shin, . "Approximate Common Knowledge and Co-ordination: Recent Lessons from Game Theory," Penn CARESS Working Papers 72042421d029130510780dde2, Penn Economics Department.
    16. Asquith, Paul & Gertner, Robert & Scharfstein, David, 1994. "Anatomy of Financial Distress: An Examination of Junk-Bond Issuers," The Quarterly Journal of Economics, MIT Press, vol. 109(3), pages 625-58, August.
    17. Houston, Joel & James, Christopher, 1996. " Bank Information Monopolies and the Mix of Private and Public Debt Claims," Journal of Finance, American Finance Association, vol. 51(5), pages 1863-89, December.
    18. Bolton, Patrick & Scharfstein, David S, 1996. "Optimal Debt Structure and the Number of Creditors," Journal of Political Economy, University of Chicago Press, vol. 104(1), pages 1-25, February.
    19. White, Michelle J, 1983. " Bankruptcy Costs and the New Bankruptcy Code," Journal of Finance, American Finance Association, vol. 38(2), pages 477-88, May.
    20. Diamond, Douglas W., 1993. "Seniority and maturity of debt contracts," Journal of Financial Economics, Elsevier, vol. 33(3), pages 341-368, June.
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