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Strategic Debt Service


  • Pierre Mella-Barral
  • William R M Perraudin


When a firm is close to bankrupcy, equity-holders may `blackmail' owners of bonds by paying less than the originally-contracted coupon payments. This paper develops simple, closed-form expressions for bond and equity values when such blackmail effects are present. Furthermore, we show that blackmail is optimal in the following sense. Without blackmail, leverage generates agency costs because value-maximizing equity-holders liquidate firms at output price levels other than the ex-ante optimum. However, if equity-holders can extract surplus from bond-holders through blackmail, they will actually choose to liquidate the firm at the ex ante optimal shut-down point.

Suggested Citation

  • Pierre Mella-Barral & William R M Perraudin, 1993. "Strategic Debt Service," CEPR Financial Markets Paper 0039, European Science Foundation Network in Financial Markets, c/o C.E.P.R, 77 Bastwick Street, London EC1V 3PZ..
  • Handle: RePEc:cpr:ceprfm:0039

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    References listed on IDEAS

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    11. Kees G. Koedijk & Philip A. Stork & Casper G. De Vries, 1998. "An EMS target zone model in discrete time," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 13(1), pages 31-48.
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    Debt Service; Corporate Bonds; Agency Costs;


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