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Resolution of financial distress under agency frictions

Santiago Moreno-Bromberg and Quynh-Anh Vo ()

Journal of Banking & Finance, 2017, vol. 82, issue C, 40-58

Abstract: We introduce, in a dynamic-contracting framework with moral hazard, the possibility of recapitalization as an alternative to liquidation when a firm is distressed. This is achieved by considering a risk-averse agent and by allowing (but not requiring) the latter to inject additional capital into the firm when necessary. We show that firm recapitalization may arise in an optimal, long-term contract. As a consequence, we find that there are two mechanisms at a firm’s disposal so as to deal with financial difficulties: one corresponds to a recapitalization process, the other to a liquidation one. The choice of mechanism is based on a cost-benefit analysis.

Keywords: Dynamic financial contracting; Moral hazard; Recapitalization; Liquidation (search for similar items in EconPapers)
JEL-codes: D82 G32 G33 (search for similar items in EconPapers)
Date: 2017
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Handle: RePEc:eee:jbfina:v:82:y:2017:i:c:p:40-58