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The Dynamics of Default and Debt Reorganization

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  • Mella-Barral, Pierre

Abstract

This article documents the fact that when debtors decide to default on their obligations too early, it is in the creditors' collective interest, as residual claimants, to make concessions prior to forcing a costly liquidation. Symmetrically, when debtors prefer to default at an inefficiently late stage, it is in the creditors' interest to propose a departure from the absolute priority rule. This article develops a continuous time pricing model of dynamic debt restructuring that reflects the crucial influence of the two counterparties' relative bargaining power. Simple and intuitive path-dependent pricing formulae are derived for equity and debt. The debt capacity as well as the evolution of the firm's capital structure throughout its existence is provided. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

Suggested Citation

  • Mella-Barral, Pierre, 1999. "The Dynamics of Default and Debt Reorganization," Review of Financial Studies, Society for Financial Studies, vol. 12(3), pages 535-578.
  • Handle: RePEc:oup:rfinst:v:12:y:1999:i:3:p:535-78
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