Debt Valuation, Renegotiation, and Optimal Dividend Policy

Hua Fan and Suresh M Sundaresan

The Review of Financial Studies, 2000, vol. 13, issue 4, 1057-99

Abstract: 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. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

Date: 2000
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