On Debt Service and Renegotiation when Debt-holders Are More Strategic

Jean-Marc Bourgeon and Georges Dionne ()

Cahiers de recherche from CIRPEE

Abstract: The contingent claims analysis of the firm financing often presents a debt renegotiation game with a passive bank which does not use strategically its capability to force liquidation, contrary towhat is observed in practice. The first purpose of this paper is to introduce more strategic bank behaviour into the continuous-time model developed by Mella-Barral and Perraudin (1997) and Hackbarth, Hennessy, and Leland (2007). Its second purpose is to account for variations in the information obtained by the parties during the contract period. We show that with public information and private debt only, the optimal probability of debt renegotiation is fixed by the firm's anticipated liquidation value. When we add public debt and asymmetric information, the good-type firm may be tempted to mimic the bad-type to reduce its debt service. We show that to deter such mimicking, banks may sometimes refuse to renegotiate with strong firms having a low liquidation value. Our results are in line with the empirical observation that recovery rate at emergence of bankruptcy is function of the share of private debt in all the firm's debt and is relatively low.

Keywords: Debt service; debt renegotiation; recovery rate; strategic bank; bankruptcy; contingent claim (search for similar items in EconPapers)
JEL-codes: D81 G13 G32 G33 (search for similar items in EconPapers)
Date: 2007
New Economics Papers: this item is included in nep-ban
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Related works:
Journal Article: On debt service and renegotiation when debt-holders are more strategic (2013)
Working Paper: On debt service and renegotiation when debt-holders are more strategic (2013)
Working Paper: On debt service and renegotiation when debt-holders are more strategic (2007)
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Persistent link: https://EconPapers.repec.org/RePEc:lvl:lacicr:0729

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