Optimal Default and Liquidation with Tangible Assets and Debt Renegotiation
AbstractThis paper proposes a new pricing model for corporate securities issued by a levered firm with the possibility of debt renegotiation. We take the structural approach that the firm's earnings follow a geometric Brownian motion with stochastic collaterals. While equity holders can default the firm for their own benefits when the earnings become insufficient to go on the firm, they may want to liquidate it by repaying the face value of debt to debt holders in order to get enough residuals, when the value of collaterals becomes sufficiently high. Unlike the existing theoretical models, the bivariate structure enables us to distinguish strategic default, liquidity default and the ordinary liquidation. It is shown that liquidity default and liquidation possibly occur without entering debt renegotiation, which makes the contribution of strategic debt service to credit spreads lower than that obtained in the previous models, irrespective of the equity holders' bargaining power. Our model resolves the inconsistency reported in recent empirical studies.
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Bibliographic InfoPaper provided by Graduate School of Economics and Business Administration, Hokkaido University in its series Discussion paper series. A with number 224.
Length: 57 pages
Date of creation: May 2010
Date of revision:
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More information through EDIRC
Structural model; Debt renegotiation; Strategic debt service; Credit spread; Liquidity default; Strategic default; Liquidation; M&A; D81; G32; G33; G35;
Find related papers by JEL classification:
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
- G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
- G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
- G35 - Financial Economics - - Corporate Finance and Governance - - - Payout Policy
This paper has been announced in the following NEP Reports:
- NEP-ALL-2010-08-14 (All new papers)
- NEP-BAN-2010-08-14 (Banking)
- NEP-BEC-2010-08-14 (Business Economics)
- NEP-DGE-2010-08-14 (Dynamic General Equilibrium)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Mella-Barral, Pierre & Perraudin, William, 1997.
" Strategic Debt Service,"
Journal of Finance,
American Finance Association, vol. 52(2), pages 531-56, June.
- Mella-Barral, Pierre, 1999. "The Dynamics of Default and Debt Reorganization," Review of Financial Studies, Society for Financial Studies, vol. 12(3), pages 535-78.
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