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The Optimal Response to Default: Renegotiation or Extended Maturity?

Author

Listed:
  • Thomas Miceli

    (University of Connecticut)

  • C. F. Sirmans

    (University of Connecticut)

Abstract

This paper reinforces the argument of Harding and Sirmans (2002) that the observed preference of lenders for extended maturity rather than renegotiation of the principle in the case of loan default is due to the superior incentive properties of the former. Specifically, borrowers have a greater incentive to avoid default under extended maturity because it reduces the likelihood that they will be able to escape paying off the full loan balance. Thus, although extended maturity leaves open the possibility of foreclosure, it will be preferred to renegotiation as long as the dead weight loss from foreclosure is not too large.

Suggested Citation

  • Thomas Miceli & C. F. Sirmans, 2007. "The Optimal Response to Default: Renegotiation or Extended Maturity?," Working papers 2007-11, University of Connecticut, Department of Economics.
  • Handle: RePEc:uct:uconnp:2007-11
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    File URL: http://web2.uconn.edu/economics/working/2007-11.pdf
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    References listed on IDEAS

    as
    1. John P. Harding & C.F. Sirmans, 2002. "Renegotiation of Troubled Debt: The Choice between Discounted Payoff and Maturity Extension," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 30(3), pages 475-503.
    2. Paul Asquith & Robert Gertner & David Scharfstein, 1994. "Anatomy of Financial Distress: An Examination of Junk-Bond Issuers," The Quarterly Journal of Economics, Oxford University Press, vol. 109(3), pages 625-658.
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    More about this item

    Keywords

    Agency costs; default; extended maturity; renegotiation; moral hazard;

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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