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Co-ordination failure and the role of banks in the resolution of financial distress

  • Spyros Pagratis
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    This article discusses the out-of-court restructuring of the contractual obligations of a financially distressed firm, under conditions of asymmetric information among the firm’s creditors and in situations where a creditor bank makes concessions conditional on other creditors’ actions. I show that a bank’s conditional commitment to support the financially distressed firm may inject a degree of strategic solidity among other creditors and reduce the deadweight costs of inefficient liquidation. However, should a bank’s concession be made conditional on a high tendering rate by other creditors, this may negate the positive information externality of bank’s action. Low minimum tendering rates, on the other hand, may lead to multiple equilibria in creditors’ strategies; but, all those equilibria are shown to be Pareto improving of the unique equilibrium when there is no bank in the game.

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    File URL: http://eprints.lse.ac.uk/24939/
    File Function: Open access version.
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    Paper provided by London School of Economics and Political Science, LSE Library in its series LSE Research Online Documents on Economics with number 24939.

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    Length: 32 pages
    Date of creation: 16 Feb 2004
    Date of revision:
    Handle: RePEc:ehl:lserod:24939
    Contact details of provider: Postal: LSE Library Portugal Street London, WC2A 2HD, U.K.
    Phone: +44 (020) 7405 7686
    Web page: http://www.lse.ac.uk/

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    1. White, Michelle J, 1983. " Bankruptcy Costs and the New Bankruptcy Code," Journal of Finance, American Finance Association, vol. 38(2), pages 477-88, May.
    2. Fama, Eugene F., 1985. "What's different about banks?," Journal of Monetary Economics, Elsevier, vol. 15(1), pages 29-39, January.
    3. Stephen Morris & Hyun Song Shin, 2001. "Coordination risk and the price of debt," LSE Research Online Documents on Economics 25046, London School of Economics and Political Science, LSE Library.
    4. Stephen Morris & Hyun Song Shin, . "Approximate Common Knowledge and Co-ordination: Recent Lessons from Game Theory," Penn CARESS Working Papers 72042421d029130510780dde2, Penn Economics Department.
    5. Carlsson, H. & van Damme, E.E.C., 1993. "Global games and equilibrium selection," Other publications TiSEM 49a54f00-dcec-4fc1-9488-4, Tilburg University, School of Economics and Management.
    6. Stephen Morris & Hyun Song Shin, 2001. "Rethinking Multiple Equilibria in Macroeconomic Modeling," NBER Chapters, in: NBER Macroeconomics Annual 2000, Volume 15, pages 139-182 National Bureau of Economic Research, Inc.
    7. Bolton, Patrick & Scharfstein, David S, 1996. "Optimal Debt Structure and the Number of Creditors," Journal of Political Economy, University of Chicago Press, vol. 104(1), pages 1-25, February.
    8. Berlin, Mitchell & John, Kose & Saunders, Anthony, 1996. "Bank Equity Stakes in Borrowing Firms and Financial Distress," Review of Financial Studies, Society for Financial Studies, vol. 9(3), pages 889-919.
    9. Giammarino, Ronald M, 1989. "The Resolution of Financial Distress," Review of Financial Studies, Society for Financial Studies, vol. 2(1), pages 25-47.
    10. James, Christopher, 1995. "When Do Banks Take Equity in Debt Restructurings?," Review of Financial Studies, Society for Financial Studies, vol. 8(4), pages 1209-34.
    11. Houston, Joel & James, Christopher, 1996. " Bank Information Monopolies and the Mix of Private and Public Debt Claims," Journal of Finance, American Finance Association, vol. 51(5), pages 1863-89, December.
    12. Diamond, Douglas W., 1993. "Seniority and maturity of debt contracts," Journal of Financial Economics, Elsevier, vol. 33(3), pages 341-368, June.
    13. Vives, X., 1988. "Nash Equilibrium With Strategic Complementarities," UFAE and IAE Working Papers 107-88, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC).
    14. Asquith, Paul & Gertner, Robert & Scharfstein, David, 1994. "Anatomy of Financial Distress: An Examination of Junk-Bond Issuers," The Quarterly Journal of Economics, MIT Press, vol. 109(3), pages 625-58, August.
    15. White, Michelle J, 1989. "The Corporate Bankruptcy Decision," Journal of Economic Perspectives, American Economic Association, vol. 3(2), pages 129-51, Spring.
    16. Gilson, Stuart C. & John, Kose & Lang, Larry H. P., 1990. "Troubled debt restructurings*1: An empirical study of private reorganization of firms in default," Journal of Financial Economics, Elsevier, vol. 27(2), pages 315-353, October.
    17. Morris, Stephen, 1995. "The Common Prior Assumption in Economic Theory," Economics and Philosophy, Cambridge University Press, vol. 11(02), pages 227-253, October.
    18. Morris, S & Song Shin, H, 1996. "Unique Equilibrium in a Model of Self-Fulfilling Currency Attacks," Economics Papers 126, Economics Group, Nuffield College, University of Oxford.
    19. Hyun Shin, 2001. "Coordination Risk and the Price of Debt," Economics Series Working Papers 1999-W25, University of Oxford, Department of Economics.
    20. Morris, Stephen & Shin, Hyun Song, 1999. "Risk Management with Interdependent Choice," Oxford Review of Economic Policy, Oxford University Press, vol. 15(3), pages 52-62, Autumn.
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