investment based financing constraints and debt renegotiation we consider how equity holders bargaining power during financial distress influences the interactions between financing and investment decisions when the firm faces the upper limit of debt issuance we obtain four results first weaker equity holders bargaining power is more likely that the firm is financially constrained second the investment quantity is independent of equity holders bargaining power third the constrained credit spreads are increasing with equity holders bargaining power contrary to the unconstrained ones fourth higher volatility and weaker equity holders bargaining power are likely that the firm prefers to issue debt with renegotiation compared with debt without renegotiation c 2014 elsevier b v all rights reserved

a theory of corporate financial decisions with liquidity and solvency concerns this paper studies the impact of both liquidity and solvency concerns on corporate finance i present a tractable model of a firm that optimally chooses capital structure cash holdings dividends and default while facing cash flows with long term uncertainty and short term liquidity shocks the model explains how changes in solvency affect liquidity and also how liquidity concerns affect solvency via capital structure choice these interactions result in a dynamic cash policy in which cash reserves increase in profitability and are positively correlated with cash flows the optimal dividend distributions implied by the model are smoothed relative to cash flows i also find that liquidity concerns lead to a decrease of dispersion of credit spreads

dynamic investment and financing under personal taxation this paper examines the effects of capital gains taxation on firms investment and financing decisions we develop a real options model in which the timing of investment the decision to default and the firm s capital structure are endogenously and jointly determined our analysis demonstrates that the asymmetric taxation of capital gains and losses fosters investment by eroding the option value of waiting it also shows that firms controlled by taxable investors employ more equity financing the higher the firm s stock price and the worse the firm s historical performance using a large sample of u s industrial firms that are owned by taxable investors between 1970 and 2008 we present new evidence on corporate investment and financing policies which is supportive of the model s predictions

refinancing profitability and capital structure abstract we revisit the well established puzzle that leverage is negatively correlated with measures of profitability in contrast we find that at times when firms are at or close to their optimal level of leverage the cross sectional correlation between profitability and leverage is positive at other times it is negative these results are consistent with dynamic trade off models in which infrequent capital structure rebalancing is optimal the time series of market leverage and profitability in the quarters prior to rebalancing events match the patterns predicted by these models our results are not driven by investment layouts market timing payout or mechanical mean reversion of leverage

investment under uncertainty with strategic debt service the presence of a well designed bankruptcy code is an important part of the nancialarchitecture in developed economies by allowing the creditors to seize the assets of theborrowers who fail to make contractual payments the code generates bene cial ex ante e ectson debt capacity and rm value by giving the borrowers options to renegotiate their debtobligations and seek bankruptcy protection the code increases the likelihood that borrowersmay avoid ine cient ex post liquidation as hart 1999 notes the code should balanceex ante rm value maximization with ex post e ciency the bankruptcy codes in di erentcountries weight this tradeo di erently and hence vary in terms of the distribution of rightsand powers between borrowers and lenders in this paper we provide an inter temporal framework to examine how the creditors liquidation rights and the distribution of ex post bargaining powers in uence the rm s in vestment and nancing decisions and a ect ex ante rm value we show that strongerequityholders bargaining power lowers debt capacity reduces rm value and discouragesgrowth option exercising our calibration suggests that the quantitative e ects of ex poststrategic renegotiation on ex ante rm value may be large our paper provides an attempt to integrate nancial architecture into the theory of in vestment growth option exercising by building on two strands of literature investment anddebt pricing we extend the real options approach to investment pioneered by mcdonaldand siegel 1986 and brennan and schwartz 1985 to allow for capital structure decisionsunder strategic debt service we also draw insights from corporate debt pricing capital struc ture literature which focuses on leverage and security pricing after investment has alreadybeen made merton 1974 black and cox 1976 and leland 1994 our paper bridgesthe gap between these two strands of literature by characterizing the optimal investment and nancing decisions and the option value of waiting in closed form we show that the inter action between nancing and investment decisions in the presence of strategic debt servicegenerates new insights and also quantitatively important e ects on ex ante rm value

can the trade off theory explain debt structure we examine the optimal mixture and priority structure of bank and market debt using a tradeoff model where banks have the unique ability to renegotiate outside formal bankruptcy flexible bank debt offers a superior tradeoff between tax shields and bankruptcy costs ease of renegotiation limits bank debt capacity however optimal debt structure hinges upon which party has bargaining power in private workouts weak firms have high bank debt capacity and utilize bank debt exclusively strong firms lever up to their lower bank debt capacity augment with market debt and place the bank senior therefore the tradeoff theory offers an explanation for i why young small firms use bank debt exclusively ii why large mature firms employ mixed debt financing and iii why bank debt is senior the tradeoff theory also generates predictions consistent with international evidence in countries where the bankruptcy regime entails soft tough enforcement of contractual priority bank debt capacity is low high implying greater less reliance on market debt

temporary versus permanent shocks explaining corporate financial policies we investigate corporate financial policies in the presence of both temporary and permanent shocks to firms cash flows in our framework cash flows can be negative and are imperfectly correlated with firm value and earnings volatility differs from asset volatility these results are consistent with empirical stylized facts they are also contrary to the implications of existing dynamic capital structure models that allow only for permanent shocks to cash flows temporary shocks increase the importance of financial flexibility and may provide an intuitively simple and realistic explanation of empirically observed financial conservatism and low leverage phenomena the theoretical framework developed in this article general enough to be used in various corporate finance applications jel g12 g32 g33

convertible bond underpricing renegotiable covenants seasoning and convergence we investigate the long standing puzzle on the underpricings of convertible bonds we hypothesize that the observed underpricing is induced by the possibility that a convertible bond might renegotiate on some of its covenants e g an imbedded put option in financial difficulties consistent with our hypothesis we find that the initial underpricing is larger for lower rated bonds the underpricing worsens if the issuer experiences subsequent financial difficulties however conditional on no rating downgrades our main empirical result shows that convertible bond prices do converge to their theoretical prices within two years this seasoning period is shorter for higher rated convertible bonds

credit market frictions and capital structure dynamics we study the implications of credit market frictions for the dynamics of corporate capital structure and the risk of default of corporations to do so we develop a dynamic capital structure model in which firms face uncertainty regarding their ability to raise funds in credit markets and have to search for investors when seeking to adjust their capital structure we provide a general analysis of shareholders dynamic financing and default decisions show when markov perfect equilibria in financing and default barrier strategies exist and when uniqueness can be achieved we then use the model to generate a number of novel testable implications relating credit market frictions to target leverage the pace and size of capital structure changes creditor turnover and the likelihood of default c 2014 elsevier inc all rights reserved

a dynamic program for valuing corporate securities abstract we design and implement a dynamic program for valuing corporate securities seen as derivatives on a firm s assets and computing the term structure of yield spreads and default probabilities our setting is flexible for it accommodates an extended balance sheet equality arbitrary corporate debts multiple seniority classes and a reorganization process this flexibility comes at the expense of a minor loss of efficiency the analytical approach proposed in the literature is exchanged here for a quasi analytical approach based on dynamic programming coupled with finite elements to assess our construction which shows flexibility and efficiency we carry out a numerical investigation along with a complete sensitivity analysis

optimal capital structure and bankruptcy choice dynamic bargaining versus liquidation abstract we model a firm s optimal capital structure decision in a framework in which it may later choose to enter either chapter 11 reorganization or chapter 7 liquidation creditors anticipate equityholders ex post reorganization incentives and price them into the ex ante credit spreads using a realistic dynamic bargaining model of reorganization we show that the off equilibrium threat of costly renegotiation can lead to lower leverage even with liquidation in equilibrium if reorganization is less efficient than liquidation the added option of reorganization can actually make equityholders worse off ex ante even when they liquidate on the equilibrium path

bank capital and dividend externalities dividend payouts erode equity capital and affect the relative value of claims on a bank through this channel when banks have contingent claims on each other one bank s capital policy affects the equity value and risk of default for other banks when such externalities are strong bank capital becomes a public good whereby the private equilibrium features excessive dividends and inefficient recapitalization relative to the efficient policy that maximizes total banking sector equity we relate these implications to the observed bank behaviour during the crisis of 2007 2009

continuous time methods in finance a review and an assessment i survey and assess the development of continuous time methods in finance during the last 30 years the subperiod 1969 to 1980 saw a dizzying pace of development with seminal ideas in derivatives securities pricing term structure theory asset pricing and optimal consumption and portfolio choices during the period 1981 to 1999 the theory has been extended and modified to better explain empirical regularities in various subfields of finance this latter subperiod has seen significant progress in econometric theory computational and estimation methods to test and implement continuous time models capital market frictions and bargaining issues are being increasingly incorporated in continuous time theory the roots of modern continuous time methods in finance can be traced back to the seminal contributions of merton 1969 1971 1973b in the late 1960s and early 1970s merton 1969 pioneered the use of continuous time modeling in financial economics by formulating the intertemporal consumption and portfolio choice problem of an investor in a stochastic dynamic programming setting merton 1973b also showed how such a framework can be used to develop equilibrium asset pricing implications thereby significantly extending the asset pricing theory to richer dynamic settings and expanding the scope of applications of continuous time methods to study problems in financial economics 1 within a span of about 30 years from the publication of merton s inf luential papers continuous time methods have become an integral part of financial economics indeed in certain core areas in finance such as e g asset pricing derivatives valuation term structure theory and portfolio selection continuoustime methods have proved to be the most attractive way to conduct research and gain economic intuition the continuous time approach in these areas has produced models with a rich variety of testable implications the econometric theory for testing continuous time models has made rapid strides in the last decade and has thus kept pace with the impressive progress on the theoretical front one hopes that the actual empirical investigations and estimation using the new procedures will follow suit soon

debt renegotiation and debt overhang evidence from lender mergers this paper studies whether debt renegotiation mitigates debt overhang and improves investment efficiency using mergers between lenders participated in the same syndicated loans as natural experiments that exogenously reduce the number of lenders and thus make renegotiation easier i find that firms affected by the mergers experience more loan renegotiations and increase capital expenditure investment i also find that the effect is stronger for firms with higher q suggesting improved investment efficiency further evidence suggests that the effect concentrates on loans without performance pricing provisions and unsecured loans providing further support that lender mergers improves investment efficiency for firms suffering from debt overhang ex ante

distress risk premia in expected stock and bond returns abstract prior studies find that shareholders strategic actions over debtholders are significant for stock prices but not for bond prices i find that for firms with private and public debt strategic default has no significant effect on distress risk premia in expected stock or bond returns suggesting that the dispersion of bondholders greatly weakens the shareholder advantage effect the shareholder advantage effect on stock prices is only significant for firms with only private debt and to some degree affected by the dispersion of stockholders and complexity in capital structure overall renegotiation friction helps explain the cross sectional implications of strategic default for stock and bond prices

financial distress stock returns and the 1978 bankruptcy reform act we study distress risk premia around a bankruptcy reform that shifts bargaining power in financial distress from debtholders to shareholders we find that the reform reduces risk factor loadings and returns of distressed stocks the reform effect is stronger for firms with lower firm level shareholder bargaining power an increase in credit spreads of riskier relative to safer firms in particular for firms with lower firm level shareholder bargaining power confirms a shift in bargaining power from bondholders to shareholders out of sample tests reveal that a reversal of the reform s effect leads to a reversal of factor loadings and returns

asset sale debt restructuring and liquidation this paper considers a dynamic model in which shareholders of a firm in distress have a choice of whether the firm proceeds to debt restructuring or direct liquidation at an arbitrary time in the model we show the following results fewer asset sales lower financing debt renegotiation and running costs a lower premium to the debt holders a lower cash flow volatility and a higher initial coupon increase the shareholders incentive to choose debt restructuring to avoid full liquidation in the debt renegotiation process the shareholders arrange the coupon reduction and use equity financing to retire a part of the debt value to the debt holders the timing of debt restructuring always coincides with that of liquidation without debt renegotiation most notably the shareholders do not prefer asset sale in debt restructuring even if they face high financing costs the possibility of debt renegotiation in the future increases the initial leverage ratio in the optimal capital structure

strategic analysis of contingent claims traditional contingent claims analysis provides an elegant and complete model of the financing of the dynamic firm but has difficulty fitting the observations in the market recent work in corporate finance suggests this is because of its failure to model financial distress realistically we survey recent efforts to address this issue by deriving valuation formulae from the analysis of non cooperative equilibria in extensive form games we illustrate how a simple static bankruptcy model can be incorporated in a dynamic game we then show how to find the continuous time equivalent of this game this we use to find closed form bond formulae in special cases and to exploit efficient numerical techniques generally

capital structure under costly enforcement we consider financial structure and repayment behavior in a setting where cash flows are private information to the entrepreneur and the cost of enforcing repayment differs across security holders if enforcement costs are lower for shareholders than for creditors a mixed capital structure with debt and equity can obtain in equilibrium under a mixed capital structure creditors intervene in low cash flow states while shareholders intervene in high cash flow states moreover strategic defaults costly bankruptcy shareholder intervention and violation of absolute priority occur with positive probability on the equilibrium path several of the predictions from our framework are consistent with evidence not readily explainable by existing theories

the slicing approach to valuing tax shields abstract the literature develops the theoretical rationale for the value of tax shields vts on the following misguided basis it uses required rate of return on assets or wacc as the discount rate for capitalization it uses expected rate of return on assets roa or roi as a proxy for wacc and it is not aware of 1 the influence of the difference between expected rate of return on equity and required rate of return on equity rroe on vts 2 the fact that rroe is equity normal profit which is not measurable 3 the economic content of the weight attached to the vts capacity and 4 the co definition of tax shield and leverage return this paper takes tax shields and leverage return as a system and provides a knife interest rate roi cost price to slice the vts capacity into earned vts and unearned vts earned vts is vts unearned vts is the value of leverage return because leverage return is tax payable

the implications of wto and gats for the banking sector in africa in this paper we assess the implications of the world trade organisation wto and the general agreement on trade in services gats for the banking sector in african signatory countries with emphasis on the free trade element we first review the relevant provisions of the gats for banking services and the main exemptions held by african countries we then analyse the main efficiency indicators for a sample of the top banks in 18 african economies for the period 1997 1998 we also use univariate statistics to analyse the dispersion of the key bank pricing and liquidity indicators in these economies for the period 1994 1998 the main findings imply that although full liberalization implicit in the wto and gats protocols will lead to a substantial shake up of the african banking industry however provided they have an appropriate regulatory framework and allow sufficient lead time most african countries have little to fear from liberalization at least in terms of the continuing existence of a locally owned banking industry and indeed these countries could reasonably expect to be able to restructure and compete at the very least in african wide or regional markets

efficient liability rules for an economy with non identical individuals abstract this paper is about accident situations involving two risk neutral parties both parties engage in activities that are profitable but affect the magnitude of possible bilateral accidents we analyse how the activity choices can be decentralized by liability rules that assign the costs to the two parties to an accident we show that rules which share damages are superior to rules where one party bears the entire accident costs

capital structure debt maturity and stochastic interest rates this article develops a model in which optimal capital structure and debt maturity are jointly determined in a stochastic interest rate environment the model yields leverage ratios that are consistent in spirit with empirical observations the optimal maturity and credit spread of an optimally issued debt are found to be smaller than observed values the long run mean of the interest rate is found to be a key variable in determining optimal capital structure and debt maturity furthermore the interest rate volatility and the correlation between the interest rate and the firm s asset value play important roles in determining debt maturity

assessing the benefits to developing countries of liberalisation in services trade this paper discusses the potential impacts of services trade liberalisation on developing countries and reviews existing quantitative studies its purpose is to distill themes from current literature rather than to advocate specific policy changes the picture emerging is one of valiant attempts to quantify in the presence of formidable analytical and data problems yielding only a clouded image of likely impacts on trade consumption production and welfare emerging to the point that the policy implications of results are not always clear a central intuition would seem to be that with genuine two sided oecd non oecd liberalisation in services that are seemingly considerably labour intensive in delivery the potential should be there for significant developing country gains from global liberalisation allowing full cross border delivery however this picture is neither fully endorsed by available studies neither is it explicitly contradicted this seems to be the case for a number of reasons one difficulty with the studies is that the conceptual underpinnings of what determines trade in services and how this trade differs analytically from that of trade in goods if at all is an issue prior to assessments of impacts of liberalisation of trade in services on developing countries being discussed key issues here are the treatment of mobility for service providers both firms and workers and the differing analytical structures needed to analyse individual service items banking insurance telecoms etc some recent analytical work suggests that liber alisation in some service items such as banking need not always yield gains and this contrasts with quantitative studies where analytical structures mirror conventional trade in goods treatments the discussion and measurement of barriers to service trade in both developed and developing countries is also problematic one is talking of domestic regulation entry barriers portability of providers competition policy regimes more so than only barriers at national borders as with tariffs both representing and quantifying such barriers raise major difficulties and these are also spelled out in the paper which barriers actually restrict trade and which do not because they are redundant is one issue for instance it is also often misleading to represent barriers in simple ad valorem equivalent form as a result numerical modelling work on the effects of service trade barriers which is based on ad valorem equivalent modelling is often not fully convincing in addition individual country results vary considerably across studies in ways that it is frequently hard for outsiders to understand studies do however point towards a tentative conclusion that effects are small and positive for developed and most developing countries if fdi flow changes accompanying service trade liberalisation are excluded from the analysis but much larger and more variable across countries if they are present this could be taken to suggest that mode 3 gats liberalisation roughly captured in some studies might be important for developing countries but mode 4 gats liberalisation could be even more important given large barriers to labour flows across countries thus if service trade liberalisation is thought of primarily as a surrogate for improved functioning of global factor markets in which more capital flows to developing countries and more labour flows from them to developed countries then developing countries could benefit in a major way from genuine two sided oecd non oecd liberalisation developing countries fear however that in global negotiations on services liberalisation where there is an asymmetry of power that largely one sided liberalisation may be the outcome and their gains will be correspondingly limited the paper concludes by evaluating econometric studies on linkage between services liberalisation and country growth rules and briefly discusses some key sectoral issues in health services and transportation

cash flow shortage as an endogenous bankruptcy reason abstract this paper develops a simple model for a leveraged firm and endogenizes the firm s bankruptcy point by assuming that equity issuance is costly equity issuance costs reflect the difficulties in issuing new equity for firms that are close to financial distress the resulting model captures cash flow shortage as a reason to go bankrupt though the equity value is positive i analyze the optimal bankruptcy point as well as corporate bond prices and yield spreads for various levels of equity issuance costs in order to study the impact of different liquidity constraints finally i discuss the consequences on optimal capital structure

strategic debt service and investment decisions firms alter investing decisions when there is debt in the capital structure security design features can exacerbate the situation this article studies how strategic debt service may affect investment distortions resulting from debt financing in a dynamic framework when the production decision involves an expansion option the shareholders option to strategically default on the outstanding debt eliminates bankruptcy costs but in contrast to previous literature where production decisions are fixed leads to suboptimal investing decisions this is due to higher wealth transfers from shareholders to debt holders upon exercise of the growth option strategic debt service therefore may reduce the value of the firm the setting of an endogenous production set offers a potential explanation for empirical observations of wide credit spreads and low leverage

liquidation fire sales and acquirers private information abstract we develop a dynamic model in which a distressed firm optimizes an exit choice between sell out and default as well as its timing we assume that the distressed firm is not informed about the acquirer s asset valuation we show that the firm delays liquidation to decrease the acquirer s information rent notably the firm can change the exit choice from sell out to default when the screening cost is high in this case shareholders declare default regardless of the acquirer s valuation which provides the acquirer the maximum information rent together with the deadweight costs of bankruptcy the maximal information rent which causes a wealth transfer from debt holders of the bankrupt firm to the acquirer lowers the sales price and debt recovery this mechanism can explain many empirical findings about fire sales and acquirers excess gains higher volatility leverage and asymmetric information increase the likelihood of a fire sale but higher bankruptcy costs could play a positive role in preventing a fire sale with asymmetric information the firm can reduce debt issuance to avoid the risk of a fire sale

optimal debt and equity values in the presence of chapter 7 and chapter 11 explicit presence of reorganization in addition to liquidation leads to conflicts of interest between borrowers and lenders in the first best outcome reorganization adds value to both parties via higher debt capacity lower credit spreads and improved overall firm value if control of the ex ante reorganization timing and the ex post decision to liquidate is given to borrowers most of the benefits are appropriated by borrowers ex post lenders can restore the first best outcome by seizing this control or by the ex post transfer of control rights reorganization is more likely and liquidation is less likely relative to the benchmark case with liquidation only the u s bankruptcy code which includes a liquidation process chapter 7 and a reorganization process chapter 11 aims to resolve a number of important issues associated with a distressed firm these issues can be classified into information asymmetry problems e g quality of the firm heinkel and zechner 1993 agency problems e g risk shifting jensen and meckling 1976 or coordination problems e g debt of various maturities berglof and von thadden 1994 in this paper we investigate whether there is a place for a reorganization process in the presence of costly financial distress and liquidation these costs capture in reduced form the aforementioned frictions we wish to characterize the states of a borrowing firm relative to its outstanding contractual debt obligations at different stages of financial distress assuming full information and a single issue of debt we also seek to determine the role played by the bankruptcy code in improving the welfare of borrowers and lenders and how its influence depends on the rights given to borrowers and lenders at various stages of financial distress more precisely we build on structural models of debt merton 1974 black and cox 1976 which allows us to determine overall firm value along with the values of equity and debt in line with this literature we assume that liquidation destroys part of the firm s value we then ask the basic and yet important

sovereign credit spreads abstract the paper develops a structural credit risk model to study sovereign credit risk and the dynamics of sovereign credit spreads the model features endogenous default and recovery rates that both depend on the interaction between domestic output fluctuations and global macroeconomic conditions we show that sovereigns choose to default at higher levels of economic output once global macroeconomic conditions are bad this yields to default rates and credit spreads that are substantially higher compared to normal times we derive closed form expressions for sovereign debt values and default times and focus on the dynamics of sovereign credit spreads as opposed to standard theories of sovereign debt this paper s structural model generates much richer default patterns and non linearities through regime shifts in the global macroeconomic environment moreover changes in the global environment reveal the interconnectedness of the financial system

evaluating corporate bonds with complicated liability structures and bond provisions this paper presents a general and numerically accurate lattice methodology to price risky corporate bonds it can handle complex default boundaries discrete payments various asset sales assumptions and early redemption provisions for which closed form solutions are unavailable furthermore it can price a portfolio of bonds that accounts for their complex interaction whereas traditional approaches can only price each bond individually or a small portfolio of highly simplistic bonds because of the generality and accuracy of our method it is used to investigate how credit spreads are influenced by the bond provisions and the change in a firm s liability structure due to bond repayments

debt valuation renegotiation and optimal dividend policy the valuation of debt and equity reorganization boundaries and firm s optimal dividend policies are studied in a framework where we model strategic interactions between debt holders and equity holders in a game theoretic setting which can accommodate varying bargaining powers to the two claimants two formulations of reorganization are presented debt equity swaps and strategic debt service resulting from negotiated debt service reductions we study the effects of bond covenants on payout policies and distinguish liquidity induced defaults from strategic defaults we derive optimal equity issuance and payout policies the debt capacity of the firm and the optimal capital structure are characterized

horses and rabbits trade off theory and optimal capital structure this paper examines optimal capital structure choice using a dynamic capital structure model that is calibrated to reflect actual firm characteristics the model uses contingent claim methods to value interest tax shields allows for reorganization in bankruptcy and maintains a long run target debt to total capital ratio by refinancing maturing debt using this model we calculate optimal capital structures in a realistic representation of the tra ditional trade off model in contrast to previous research the calculated optimal capital structures do not imply that firms tend to use too little leverage in practice we also esti mate the costs borne by a firm whose capital structure deviates from its optimal target debt to total capital ratio the costs of moderate deviations are relatively small suggesting that a policy of adjusting leverage infrequently is likely to be reasonable for many firms

term structures of credit spreads with incomplete accounting information we study the implications of imperfect information for term structures of credit spreads on corporate bonds we suppose that bond investors cannot observe the issuer s assets directly and receive instead only periodic and imperfect accounting reports for a setting in which the assets of the firm are a geometric brownian motion until informed equityholders optimally liquidate we derive the conditional distribution of the assets given accounting data and survivorship contrary to the perfect information case there exists a default arrival intensity process that intensity is calculated in terms of the conditional distribution of assets credit yield spreads are characterized in terms of accounting information generalizations are provided

theory and evidence on the resolution of financial distress we analyze a financially distressed owner managed project the main results of the model are 1 borrower default is an endogenous response to the anticipated restructuring foreclosure outcome 2 the lender s restructuring foreclosure decision depends critically on the interaction between project value and industry liquidity and 3 the lender waits for the industry to recapitalize before selling assets obtained through foreclosure empirical analysis of a large sample of defaulted commercial real estate loans supports many of the model predictions including restructuring foreclosure outcomes that are consistent with endogenous borrower default and firesale discounts that vary depending on industry market conditions at the time of foreclosure jel g33 copyright 2006 oxford university press

a binomial lattice method for pricing corporate debt and modeling chapter 11 proceedings the pricing of corporate debt is still a challenging and active research area in corporate finance starting with merton 1974 many authors proposed a structural approach in which the value of the assets of the firm is modeled by a stochastic process and all other variables are derived from this basic process these structural models have become more complex over time in order to capture more realistic aspects of bankruptcy proceedings the literature in this area emphasizes closed form solutions that are derived by either partial differential equation methods or analytical pricing techniques however it is not always possible to build a comprehensive model with realistic model features and achieve a closed form solution at the same time in this paper we develop a binomial lattice method that can be used to handle complex structural models such as ones that include chapter 11 proceedings of the u s bankruptcy code although lattice methods have been widely used in the option pricing literature they are relatively new in corporate debt pricing in particular the limited liability requirement of the equity holders needs to be handled carefully in this context our method can be used to solve the leland 1994 model and its extension to the finite maturity case the more complex model of broadie chernov and sundaresan 2005 and others

resolution of financial distress under chapter 11 abstract we develop a contingent claims model for a firm in financial distress with a formal account for renegotiations under the u s bankruptcy procedure known as chapter 11 shareholders and two classes of creditors senior and junior alternatively propose a reorganization plan subject to a vote the bankruptcy judge can intervene in any renegotiation round to impose a plan the multiple stage bargaining process is solved in a non cooperative game theory setting the calibrated model yields the liquidation rate the duration of chapter 11 and the frequency of deviations from the absolute priority rule which are consistent with empirical evidence

dividends and leverage how to optimally exploit a non renewable investment in this paper we model the situation where a non renewable investment is given for instance a resource reservoir and show how to optimally trade off between dividends and leverage in order to maximize a performance indicator for shareholders up to the bankruptcy time we then study the way market risk the volatility of the market price of the resource impacts the optimal policies and the default risk of the company the moments when the policies are rebalanced are analyzed and we give a measure of the agency costs which appear between the shareholders and the debt holders

the use of equity financing in debt renegotiation debt renegotiation is often modeled as pure debt for equity or debt for debt swaps in the theoretical literature however the empirical evidence in the debt repurchase literature shows that a combination of debt and equity along with asset sales is used in renegotiation in this paper we analyze the use of equity financing in addition to debt financing and asset sales in debt repurchases firms with larger volatility lower cash flow growth rates or higher recovery rates are more likely to use equity financing in debt renegotiation flotation and renegotiation costs the bargaining power of the creditors and macroeconomic variables also influence this choice when equity issuance is a possible source of financing in renegotiation firms optimally choose smoother coupons and welfare increases as compared to pure debt for debt swaps we provide closed form solutions for the optimal use of funding and we derive novel testable empirical implications regarding the use of equity financing in debt repurchases

default and liquidation timing under asymmetric information abstract we consider a dynamic model in which shareholders delegate the running of a firm to a manager who observes private information about the firm s running and liquidation costs we analytically derive the optimal compensation scheme contingent on the firm s cost structure information asymmetries can change the high cost firm s bankruptcy choice and timing most notably even if the liquidation value is higher than the face value of debt the high cost firm can choose default rather than liquidation to reduce the manager s information rent this can lead to the counterintuitive result that the debt value increases beyond the face value as the firm approaches default and that it jumps upward at the default time information asymmetries accelerate negative liquidation and delay positive liquidation whereas they accelerate default the optimal leverage ratio of the asymmetric information case becomes higher than that of the symmetric information case because more debt mitigates the loss due to information asymmetries our results can potentially account for many empirical findings

evaluating corporate bonds and analyzing claim holders decisions with complex debt structure abstract although many different aspects of debt structures such as bond covenants and repayment schedules are empirically found to significantly influence values of bonds and equity many theoretical structural models still oversimplify debt structures and fail to capture phenomena found in financial markets this paper proposes a carefully designed structural model that faithfully models typical complex debt structures containing multiple bonds with various covenants for example the ability for an issuing firm to meet an obligation is modeled to rely on its ability to meet previous repayments and the default trigger is shaped according to the characteristics of its debt structure such as the amount and schedule of bond repayments thus our framework reliably provides theoretical insight and concrete quantitative measurements consistent with extant empirical research such as the shapes of yield spread curves under various firm s financial statuses and the impact of payment blockage covenants on newly issued and other outstanding bonds we also develop the forest a novel quantitative method to handle contingent changes in the debt structure due to premature bond redemptions a forest consists of several trees that capture different debt structures for instance those before or after a bond redemption this method can be used to analyze how poison put covenants in the target firm s bonds influence the bidder s costs of debt financing for a leveraged buyout or investigate how the presence of wealth transfer among the remaining claim holders due to a bond redemption influences the firm s call policy or further reconcile conflicts among previous empirical studies on call delay phenomena

distressed exchange bargaining power and prior capital structure abstract financially troubled companies often make distressed exchange de offers to its creditors to postpone costly bankruptcy reorganization we derive the optimal terms and timing of a de offer consisting of debt reduction and an equity stake in the restructured firm the de terms and timing are affected by shareholder bargaining power with greater shareholder bargaining power resulting in earlier de offer smaller debt reduction and smaller equity stake the impact of shareholder bargaining power is greater when bankruptcy cost is larger and tax rate is higher we also show that renegotiability of debt increases ex ante firm value and results in a higher optimal leverage ratio both firm value and optimal leverage ratio are decreasing functions of shareholder bargaining power

default and renegotiation a dynamic model of debt we analyze the role of debt in persuading an entrepreneur to pay out cash e ows rather than to divertthem in the e rstpartof the paper we study the optimal debt contract specie cally the trade off between the size of the loan and the repayment under the assumption that some debt contract is optimal in the second part we consider a more general class of nondebt contracts and derive sufficient conditions for debt to be optimal among these