Liquidation Values and the Credibility of Financial Contract Renegotiation: Evidence from U.S. Airlines

Efraim Benmelech and Nittai K. Bergman

The Quarterly Journal of Economics, 2008, vol. 123, issue 4, 1635-1677

Abstract: How do liquidation values affect financial contract renegotiation? While the "incomplete-contracting" theory of financial contracting predicts that liquidation values determine the allocation of bargaining power between creditors and debtors, there is little empirical evidence on financial contract renegotiations and the role asset values play in such bargaining. This paper attempts to fill this gap. We develop an incomplete-contracting model of financial contract renegotiation and estimate it using data on the airline industry in the United States. We find that airlines successfully renegotiate their lease obligations downward when their financial position is sufficiently poor and when the liquidation value of their fieet is low. Our results show that strategic renegotiation is common in the airline industry. Moreover, the results emphasize the importance of the incomplete contracting perspective to real-world financial contract renegotiation.

Date: 2008
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