On debt service and renegotiation when debt-holders are more strategic

The contingent claims analysis of firm financing often presents a debt renegotiation game with a passive bank that does not use its ability to force liquidation strategically, contrary to what is observed in practice. We consider two motives that may lead a bank to refuse to renegotiate: maintaining...

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Bibliographic Details
Published in:Journal of financial intermediation 2013-07, Vol.22 (3), p.353-372
Main Authors: Bourgeon, Jean-Marc, Dionne, Georges
Format: Article
Language:English
Subjects:
Bankruptcy
Banks
Company insolvency
Contingent claim
Debt
Debt management
Debt renegotiation
Debt service
Economics and Finance
Financial services
Firm budgets
Firm value
General Finance
Humanities and Social Sciences
Probability
Quantitative Finance
Recovery rate
Strategic bank
Studies
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Summary:The contingent claims analysis of firm financing often presents a debt renegotiation game with a passive bank that does not use its ability to force liquidation strategically, contrary to what is observed in practice. We consider two motives that may lead a bank to refuse to renegotiate: maintaining its reputation to preserve its future lending activity and deterring firms from overstating their debt service abatement when they renegotiate. We show that with public information and private debt only, the optimal probability of debt renegotiation is high when the firm’s anticipated liquidation value is high. Under asymmetric information about liquidation value, the high liquidation value firm may be tempted to mimic the low liquidation value firm to reduce its debt service. To deter such mimicking, banks may sometimes refuse to renegotiate with firms having a low liquidation value.
ISSN:1042-9573
1096-0473
DOI:10.1016/j.jfi.2012.09.002