Corporate Bankruptcies, Liquidation Costs and the Role of Banks
This paper develops a reputation model to discuss the role of banks in the corporate bankruptcy process. Financially distressed firms either default on their current obligations or liquidate themselves voluntarily. Banks, who interact repeatedly in the debt market, either reduce the obligations of troubled firms or pursue liquidation. The strategy of banks is determined by a trade-off between acquiring a reputation for being tough against financially distressed firms (but incurring liquidation costs) and reducing firms' obligations so as to increase the proportion of repayment (but weakening the position against future defaults). The model shows that small firms are more likely to be liquidated when they are in financial distress than larger firms. Copyright 1996 by Blackwell Publishers Ltd and The Victoria University of Manchester
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Volume (Year): 64 (1996)
Issue (Month): 0 (Suppl.)
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