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A Theory of Workouts and the Effects of Reorganization Law

  • Gertner, Robert
  • Scharfstein, David

The authors present a model of a financially distressed firm with outstanding bank debt and public debt. Coordination problems among public debtholders introduce investment inefficiencies in the workout process. In most cases, these inefficiencies are not mitigated by the ability of firms to buy back their public debt with cash and other securities--the only feasible way that firms can restructure their public debt. The authors show that Chapter 11 reorganization law increases investment and they characterize the types of corporate financial structures for which this increased investment enhances efficiency. Copyright 1991 by American Finance Association.

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Article provided by American Finance Association in its journal Journal of Finance.

Volume (Year): 46 (1991)
Issue (Month): 4 (September)
Pages: 1189-1222

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Handle: RePEc:bla:jfinan:v:46:y:1991:i:4:p:1189-1222
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  1. Bulow, Jeremy & Rogoff, Kenneth, 1991. "Sovereign Debt Repurchases: No Cure for Overhang," The Quarterly Journal of Economics, MIT Press, vol. 106(4), pages 1219-35, November.
  2. Hoshi, Takeo & Kashyap, Anil & Scharfstein, David, 1990. "The role of banks in reducing the costs of financial distress in Japan," Journal of Financial Economics, Elsevier, vol. 27(1), pages 67-88, September.
  3. Myers, Stewart C., 1977. "Determinants of corporate borrowing," Journal of Financial Economics, Elsevier, vol. 5(2), pages 147-175, November.
  4. Franks, Julian R & Torous, Walter N, 1989. " An Empirical Investigation of U.S. Firms in Reorganization," Journal of Finance, American Finance Association, vol. 44(3), pages 747-69, July.
  5. Kenneth A. Froot & David S. Scharfstein & Jeremy C. Stein, 1988. "LDC Debt: Forgiveness, Indexation, and Investment Incentives," NBER Working Papers 2541, National Bureau of Economic Research, Inc.
  6. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, vol. 3(4), pages 305-360, October.
  7. Summers, Lawrence H. & Cutler, David, 1988. "The Costs of Conflict Resolution and Financial Distress: Evidence from the Texaco-Pennzoil Litigation," Scholarly Articles 2689179, Harvard University Department of Economics.
  8. Baird, Douglas G & Picker, Randal C, 1991. "A Simple Noncooperative Bargaining Model of Corporate Reorganizations," The Journal of Legal Studies, University of Chicago Press, vol. 20(2), pages 311-49, June.
  9. repec:att:wimass:8903 is not listed on IDEAS
  10. Asquith, Paul & Mullins, David W, Jr & Wolff, Eric D, 1989. " Original Issue High Yield Bonds: Aging Analyses of Defaults, Exchanges, and Calls," Journal of Finance, American Finance Association, vol. 44(4), pages 923-52, September.
  11. Kenneth A. Froot, 1988. "Buybacks, Exit Bonds, and the Optimality of Debt and Liquidity Relief," NBER Working Papers 2675, National Bureau of Economic Research, Inc.
  12. White, Michelle J, 1983. " Bankruptcy Costs and the New Bankruptcy Code," Journal of Finance, American Finance Association, vol. 38(2), pages 477-88, May.
  13. Aivazian, Varouj A. & Callen, Jeffrey L., 1983. "Reorganization in bankruptcy and the issue of strategic risk," Journal of Banking & Finance, Elsevier, vol. 7(1), pages 119-133, March.
  14. Myers, Stewart C. & Majluf, Nicholas S., 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Journal of Financial Economics, Elsevier, vol. 13(2), pages 187-221, June.
  15. Stewart C. Myers & Nicholas S. Majluf, 1984. "Corporate Financing and Investment Decisions When Firms Have InformationThat Investors Do Not Have," NBER Working Papers 1396, National Bureau of Economic Research, Inc.
  16. Ben S. Bernanke & John Y. Campbell, 1988. "Is There a Corporate Debt Crisis?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 19(1), pages 83-140.
  17. Stulz, ReneM. & Johnson, Herb, 1985. "An analysis of secured debt," Journal of Financial Economics, Elsevier, vol. 14(4), pages 501-521, December.
  18. Giammarino, Ronald M, 1989. "The Resolution of Financial Distress," Review of Financial Studies, Society for Financial Studies, vol. 2(1), pages 25-47.
  19. 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.
  20. Jensen, Michael C, 1986. "Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers," American Economic Review, American Economic Association, vol. 76(2), pages 323-29, May.
  21. Myers, Stewart C. & Majluf, Nicolás S., 1945-, 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Working papers 1523-84., Massachusetts Institute of Technology (MIT), Sloan School of Management.
  22. Haugen, Robert A & Senbet, Lemma W, 1978. "The Insignificance of Bankruptcy Costs to the Theory of Optimal Capital Structure," Journal of Finance, American Finance Association, vol. 33(2), pages 383-93, May.
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