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The Dynamics of Corporate Debt forgiveness and Contract Renegotiation

Listed author(s):
  • Pierre Mella-Barral

Please see the more recent version of this paper titled: The Dynamics of Default and Debt Reorganization. This paper documents the fact that in the presence of direct bankruptcy costs, prior to bankruptcy, it becomes in creditors collective interest to reduce their own contractual cash-flow claims. It analyses the pricing and efficiency implications of debt forgiveness within a fully dynamic, continuous time model. Polar cases are considered in which the balance of bargaining power in debt contract renegotiation favours either debtors or creditors. Simple closed form solutions are derived for equity and debt values, debt capacity and capital structure of the firm throughout its existence. A complete comparative analysis of the agency costs and the evolution of the firms capital structure is provided.

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File URL: http://www.lse.ac.uk/fmg/workingPapers/discussionPapers/fmg_pdfs/dp230.pdf
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Paper provided by Financial Markets Group in its series FMG Discussion Papers with number dp230.

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Date of creation: Jan 1996
Handle: RePEc:fmg:fmgdps:dp230
Contact details of provider: Web page: http://www.lse.ac.uk/fmg/

References listed on IDEAS
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  1. In Joon Kim & Krishna Ramaswamy & Suresh Sundaresan, 1993. "Does Default Risk in Coupons Affect the Valuation of Corporate Bonds?: A Contingent Claims Model," Financial Management, Financial Management Association, vol. 22(3), pages -, Fall.
  2. Froot, Kenneth A & Obstfeld, Maurice, 1991. "Stochastic Process Switching: Some Simple Solutions," Econometrica, Econometric Society, vol. 59(1), pages 241-250, January.
  3. Longstaff, Francis A & Schwartz, Eduardo S, 1995. " A Simple Approach to Valuing Risky Fixed and Floating Rate Debt," Journal of Finance, American Finance Association, vol. 50(3), pages 789-819, July.
  4. Merton, Robert C., 1973. "On the pricing of corporate debt: the risk structure of interest rates," Working papers 684-73., Massachusetts Institute of Technology (MIT), Sloan School of Management.
  5. Jones, E Philip & Mason, Scott P & Rosenfeld, Eric, 1984. " Contingent Claims Analysis of Corporate Capital Structures: An Empirical Investigation," Journal of Finance, American Finance Association, vol. 39(3), pages 611-625, July.
  6. Gertner, Robert & Scharfstein, David, 1991. " A Theory of Workouts and the Effects of Reorganization Law," Journal of Finance, American Finance Association, vol. 46(4), pages 1189-1222, September.
  7. Oliver Hart & John Moore, 1994. "A Theory of Debt Based on the Inalienability of Human Capital," The Quarterly Journal of Economics, Oxford University Press, vol. 109(4), pages 841-879.
  8. Black, Fischer & Cox, John C, 1976. "Valuing Corporate Securities: Some Effects of Bond Indenture Provisions," Journal of Finance, American Finance Association, vol. 31(2), pages 351-367, May.
  9. Bergman, Yaacov Z. & Callen, Jeffrey L., 1991. "Opportunistic underinvestment in debt renegotiation and capital structure," Journal of Financial Economics, Elsevier, vol. 29(1), pages 137-171, March.
  10. Dixit, A., 1988. "Entry And Exit Decisions Under Uncertainty," Papers 91, Princeton, Department of Economics - Financial Research Center.
  11. Lucian Arye Bebchuk & Howard F. Chang, 1991. "Bargaining and the Division of Value in Corporate Reorganization," NBER Technical Working Papers 0097, National Bureau of Economic Research, Inc.
  12. 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.
  13. Kenneth A. Froot, 1988. "Buybacks, Exit Bonds, and the Optimality of Debt and Liquidity Relief," NBER Working Papers 2675, National Bureau of Economic Research, Inc.
  14. Jeffrey Sachs, 1988. "Conditionality, Debt Relief, and the Developing Country Debt Crisis," NBER Working Papers 2644, National Bureau of Economic Research, Inc.
  15. Alex Kane & Alan J. Marcus & Robert L. McDonald, 1984. "How Big is the Tax Advantage to Debt?," NBER Working Papers 1286, National Bureau of Economic Research, Inc.
  16. Miller, Merton H, 1977. "Debt and Taxes," Journal of Finance, American Finance Association, vol. 32(2), pages 261-275, May.
  17. Dumas, Bernard, 1991. "Super contact and related optimality conditions," Journal of Economic Dynamics and Control, Elsevier, vol. 15(4), pages 675-685, October.
  18. Eberhart, Allan C & Moore, William T & Roenfeldt, Rodney L, 1990. " Security Pricing and Deviations from the Absolute Priority Rule in Bankruptcy Proceedings," Journal of Finance, American Finance Association, vol. 45(5), pages 1457-1469, December.
  19. Fischer, Edwin O & Heinkel, Robert & Zechner, Josef, 1989. " Dynamic Capital Structure Choice: Theory and Tests," Journal of Finance, American Finance Association, vol. 44(1), pages 19-40, March.
  20. Smith, Gregor W, 1991. "Solution to a Problem of Stochastic Process Switching," Econometrica, Econometric Society, vol. 59(1), pages 237-239, January.
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