Strategic Debt Service

Pierre Mella-Barral and William Perraudin

Journal of Finance, 1997, vol. 52, issue 2, 531-56

Abstract: When firms experience financial distress, equity holders may act strategically, forcing concessions from debtholders and paying less than the originally contracted interest payments. This article incorporates strategic debt service in a standard, continuous time asset pricing model, developing simple closed-form expressions for debt and equity values. The authors find that strategic debt service can account for a substantial proportion of the premium on risky corporate debt. They analyze the efficiency implications of strategic debt service, showing that it can eliminate both direct bankruptcy costs and agency costs of debt. Copyright 1997 by American Finance Association.

Date: 1997
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Working Paper: Strategic Debt Service (1993)
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