Optimal Debt Design and the Role of Bankruptcy

Ernst-Ludwig von Thadden, Erik Berglof and Gérard Roland

Cahiers de Recherches Economiques du Département d'économie from Université de Lausanne, Faculté des HEC, Département d’économie

Abstract: This paper integrates the problem of designing corporate bankruptcy rules into a theory of optimal debt structure. We show that, in an incomplete-contracts framework with imperfect renegotiation, having multiple creditors increases a firm's debt capacity while increasing its incentives to default strategically. The optimal debt contract gives creditors claims that are jointly inconsistent in case of default. Bankruptcy rules, therefore, are a necessary part of the overall financing contract, to make claims consistent and to prevent a value reducing run for the assets of the firm. It is not optimal to treat creditors asymmetrically in default, but creditors may be protected by different security rights.

Keywords: bankruptcy; debt structure; contracts (search for similar items in EconPapers)
JEL-codes: G3 K2 (search for similar items in EconPapers)
Pages: 44 pages
Date: 2003-08
New Economics Papers: this item is included in nep-cfn, nep-law and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (15)

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Persistent link: https://EconPapers.repec.org/RePEc:lau:crdeep:03.13

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