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Financial Distress and Optimal Capital Structure Adjustments

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  • Heinkel, Robert
  • Zechner, Josef

Abstract

We show that asymmetric information may prevent firms with pure discount bonds from renegotiating their capital structure prior to the maturity of the debt, although this would increase the value of the firm when its prospects are poor. This inefficiency can be reduced if the firm issues debt with a risky intermediate debt payment, such as a coupon or a sinking fund payment. We also demonstrate that bankruptcy institutions leading to deviations from absolute priority can improve the timing of recapitalizations by financially distressed firms. Finally, we show that, under certain conditions, the optimal capital structure adjustment during financial distress consists of a convertible debt-for-straight debt swap. Copyright 1993 by MIT Press.

Suggested Citation

  • Heinkel, Robert & Zechner, Josef, 1993. "Financial Distress and Optimal Capital Structure Adjustments," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 2(4), pages 531-565, Winter.
  • Handle: RePEc:bla:jemstr:v:2:y:1993:i:4:p:531-65
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    Cited by:

    1. Bruno Biais & Christophe Bisiere & Jean-Paul Decamps, 2000. "A Structural Econometric Investigation of the Agency Theory of Financial Structure," Econometric Society World Congress 2000 Contributed Papers 0817, Econometric Society.
    2. Lucian Arye Bebchuk, 2001. "Ex Ante Costs of Violating Absolute Priority in Bankruptcy," NBER Working Papers 8388, National Bureau of Economic Research, Inc.
    3. Nobuyuki Isagawa & Satoru Yamaguchi & Tadayasu Yamashita, 2010. "Debt Forgiveness And Stock Price Reaction Of Lending Banks: Theory And Evidence From Japan," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 33(3), pages 267-287, September.
    4. Isagawa, Nobuyuki, 2006. "Lender's risk incentive and debt concession," International Review of Economics & Finance, Elsevier, vol. 15(2), pages 141-150.

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