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The Importance of Incomplete Information in Explaining the Existence of Costly Bankruptcy

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  • Webb, David C

Abstract

The standard theory of capital structure argues that firms trade off the tax advantage of debt against ba nkruptcy costs. R. A. Haugen and L. W. Senbet (1978) pointed out that there is a problem with this theory: if bankruptcy involves deadweig ht costs, shareholders and bondholders have an incentive to renegotia te before it occurs since in this way bankruptcy, and its costs, can be avoided. This implies costly bankruptcy will not occur and casts d oubt on the validity of the standard theory. This paper uses noncoope rative bargaining theory to formally model this idea. It then shows t hat if there is incomplete information, costly bankruptcy can occur. Copyright 1987 by The Review of Economic Studies Limited.

Suggested Citation

  • Webb, David C, 1987. "The Importance of Incomplete Information in Explaining the Existence of Costly Bankruptcy," Economica, London School of Economics and Political Science, vol. 54(215), pages 279-288, August.
  • Handle: RePEc:bla:econom:v:54:y:1987:i:215:p:279-88
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    Cited by:

    1. Detragiache, Enrica, 1995. "Adverse selection and the costs of financial distress," Journal of Corporate Finance, Elsevier, vol. 1(3-4), pages 347-365, April.
    2. Jocelyn Martel, 1991. "Bankruptcy Law and the Canadian Experience: An Economic Appraisal," Canadian Public Policy, University of Toronto Press, vol. 17(1), pages 52-63, March.
    3. Blazy, Régis & Letaief, Aziza, 2017. "When secured and unsecured creditors recover the same: The emblematic case of the Tunisian corporate bankruptcies," Emerging Markets Review, Elsevier, vol. 30(C), pages 19-41.
    4. Régis Blazy & Laurent Weill, 2006. "The Impact of Legal Sanctions on Moral Hazard when Debt Contracts are Renegotiable," LSF Research Working Paper Series 06-09, Luxembourg School of Finance, University of Luxembourg.
    5. Philippe Frouté, 2007. "Theoretical foundation for a debtor friendly bankruptcy law in favour of creditors," European Journal of Law and Economics, Springer, vol. 24(3), pages 201-214, December.
    6. Blazy, Régis & Martel, Jocelyn & Nigam, Nirjhar, 2014. "The choice between informal and formal restructuring: The case of French banks facing distressed SMEs," Journal of Banking & Finance, Elsevier, vol. 44(C), pages 248-263.
    7. Shibata, Takashi & Tian, Yuan, 2012. "Debt reorganization strategies with complete verification under information asymmetry," International Review of Economics & Finance, Elsevier, vol. 22(1), pages 141-160.
    8. Régis Blazy & Gisèle Umbhauer & Laurent Weill, 2008. "How Bankruptcy Punishment Influences the Ex-Ante Design of Debt Contracts?," LSF Research Working Paper Series 08-04, Luxembourg School of Finance, University of Luxembourg.
    9. Ying Yan, 1997. "Credit rationing, bankruptcy cost, and the optimal debt contract for small business," Working Paper 9702, Federal Reserve Bank of Cleveland.
    10. Martel, Jocelyn, 1996. "Solutions au stress financier," L'Actualité Economique, Société Canadienne de Science Economique, vol. 72(1), pages 51-78, mars.
    11. Hamoto, Azad & Correia, Ricardo, 2012. "A theoretical analysis of the stages and events experienced by financially distressed firms," DEE - Working Papers. Business Economics. WB 13115, Universidad Carlos III de Madrid. Departamento de Economía de la Empresa.
    12. Arnold, Marc, 2014. "Managerial cash use, default, and corporate financial policies," Journal of Corporate Finance, Elsevier, vol. 27(C), pages 305-325.
    13. Hege, Ulrich, 2003. "Workouts, court-supervised reorganization and the choice between private and public debt," Journal of Corporate Finance, Elsevier, vol. 9(2), pages 233-269, March.
    14. Ying Yan, 1996. "Credit Rationing, Bankruptcy Cost, and Optimal Debt Contract for Small Business," Finance 9612003, EconWPA.
    15. Régis BLAZY & Nirjhar NIGAM, 2018. "Corporate insolvency procedures in England: The uneasy case for liquidations," Working Papers of LaRGE Research Center 2018-02, Laboratoire de Recherche en Gestion et Economie (LaRGE), Université de Strasbourg.
    16. Michelle J. White, 2005. "Economic Analysis of Corporate and Personal Bankruptcy Law," NBER Working Papers 11536, National Bureau of Economic Research, Inc.
    17. Edward R. Morrison, 2009. "Bargaining around Bankruptcy: Small Business Workouts and State Law," The Journal of Legal Studies, University of Chicago Press, vol. 38(2), pages 255-307, June.
    18. Jocelyn Martel, 1996. "Solutions au stress financier : Un survol de la littérature," CIRANO Working Papers 96s-03, CIRANO.
    19. repec:eur:ejisjr:185 is not listed on IDEAS
    20. Blazy, Régis & Deffains, Bruno & Umbhauer, Gisèle & Weill, Laurent, 2013. "Severe or gentle bankruptcy law: Which impact on investing and financing decisions?," Economic Modelling, Elsevier, vol. 34(C), pages 129-144.

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