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Liquidation Values and the Credibility of Financial Contract Renegotiation: Evidence from U.S. Airlines

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  • Efraim Benmelech
  • Nittai K. Bergman

Abstract

How do liquidation values affect financial contract renegotiation? While the "incomplete-contracting" theory of financial contracting predicts that liquidation values determine the allocation of bargaining power between creditors and debtors, there is little empirical evidence on financial contract renegotiations and the role asset values play in such bargaining. This paper attempts to fill this gap. We develop an incomplete-contracting model of financial contract renegotiation and estimate it using data on the airline industry in the United States. We find that airlines successfully renegotiate their lease obligations downward when their financial position is sufficiently poor and when the liquidation value of their fieet is low. Our results show that strategic renegotiation is common in the airline industry. Moreover, the results emphasize the importance of the incomplete contracting perspective to real-world financial contract renegotiation.

Suggested Citation

  • Efraim Benmelech & Nittai K. Bergman, 2008. "Liquidation Values and the Credibility of Financial Contract Renegotiation: Evidence from U.S. Airlines," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 123(4), pages 1635-1677.
    • Handle: RePEc:oup:qjecon:v:123:y:2008:i:4:p:1635-1677.
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    File URL: http://hdl.handle.net/10.1162/qjec.2008.123.4.1635
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    JEL classification:

    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance
    • K12 - Law and Economics - - Basic Areas of Law - - - Contract Law
    • L93 - Industrial Organization - - Industry Studies: Transportation and Utilities - - - Air Transportation

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