Repeated Dilution of Diffusely Held Debt

Ulrich Hege and Pierre Mella-Barral

The Journal of Business, 2005, vol. 78, issue 3, 737-786

Abstract: Debt with many creditors is analyzed in a continuous-time pricing model of the levered firm with opportunistic renegotiation offers and default threats. Dispersed creditors accept coupon concessions only in exchange for guaranteed liquidation rights, like collateral. In the ex ante optimal debt contract, this security is provided by assets that gradually become worthless as the firm approaches the preferred liquidation conditions. Dispersed debt offers larger debt capacity than single-creditor debt and is preferable if the ex ante value of collateralizable assets is sufficiently low. Our model explains credit risk premia in excess of those supported by a single creditor with opportunistic renegotiation.

Date: 2005
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Working Paper: Repeated Dilution of Diffusely Held Debt (2005)
Working Paper: Repeated dilution of diffusely held debt (2002)
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