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Resolution of financial distress under agency frictions

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  • Moreno-Bromberg, Santiago
  • Vo, Quynh-Anh

Abstract

We introduce, in a dynamic-contracting framework with moral hazard, the possibility of recapitalization as an alternative to liquidation when a firm is distressed. This is achieved by considering a risk-averse agent and by allowing (but not requiring) the latter to inject additional capital into the firm when necessary. We show that firm recapitalization may arise in an optimal, long-term contract. As a consequence, we find that there are two mechanisms at a firm’s disposal so as to deal with financial difficulties: one corresponds to a recapitalization process, the other to a liquidation one. The choice of mechanism is based on a cost-benefit analysis.

Suggested Citation

  • Moreno-Bromberg, Santiago & Vo, Quynh-Anh, 2017. "Resolution of financial distress under agency frictions," Journal of Banking & Finance, Elsevier, vol. 82(C), pages 40-58.
    • Handle: RePEc:eee:jbfina:v:82:y:2017:i:c:p:40-58
    DOI: 10.1016/j.jbankfin.2017.05.009
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    Cited by:

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    2. Francesco Columba & Tommaso Orlando & Francesco Palazzo & Fabio Parlapiano, 2022. "The features of equity capital increases by Italian corporates," Questioni di Economia e Finanza (Occasional Papers) 709, Bank of Italy, Economic Research and International Relations Area.
    3. Kim, Woojin & Ko, YoungKyung & Wang, Shu-Feng, 2019. "Debt restructuring through equity issues," Journal of Banking & Finance, Elsevier, vol. 106(C), pages 341-356.
    4. Mark D. Walker & Qingqing Wu, 2019. "Equity issues when in distress," European Financial Management, European Financial Management Association, vol. 25(3), pages 489-519, June.

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    More about this item

    Keywords

    Dynamic financial contracting; Moral hazard; Recapitalization; Liquidation;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • 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

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