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Optimal capital structure and bankruptcy choice: Dynamic bargaining versus liquidation

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  • Antill, Samuel
  • Grenadier, Steven R.

Abstract

We model a firm’s optimal capital structure decision in a framework in which it may later choose to enter either Chapter 11 reorganization or Chapter 7 liquidation. Creditors anticipate equityholders’ ex-post reorganization incentives and price them into the ex-ante credit spreads. Using a realistic dynamic bargaining model of reorganization, we show that the off-equilibrium threat of costly renegotiation can lead to lower leverage, even with liquidation in equilibrium. If reorganization is less efficient than liquidation, the added option of reorganization can actually make equityholders worse off ex-ante, even when they liquidate on the equilibrium path.

Suggested Citation

  • Antill, Samuel & Grenadier, Steven R., 2019. "Optimal capital structure and bankruptcy choice: Dynamic bargaining versus liquidation," Journal of Financial Economics, Elsevier, vol. 133(1), pages 198-224.
  • Handle: RePEc:eee:jfinec:v:133:y:2019:i:1:p:198-224
    DOI: 10.1016/j.jfineco.2018.05.012
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    More about this item

    Keywords

    Capital structure; Bankruptcy; Default; Dynamic bargaining;
    All these keywords.

    JEL classification:

    • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
    • C78 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Bargaining Theory; Matching Theory
    • 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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