Debt Valuation, Renegotiation, and Optimal Dividend Policy

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.

Capital Structure and Asset Prices: Some Effects of Bankruptcy Procedures

“…These equations hold for situations in which (i) default leads to an immediate liquidation of the firm's assets or (ii) shareholders have no bargaining power and hence do not extract any surplus from renegotiation. When and renegotiation is costless ( ), equations (11) and (12) are d r ϩϱ J p 0 similar to those provided by Fan and Sundaresan (2000) where default never leads to liquidation.…”

Strategic Default, Debt Structure, and Stock Returns

“…This paper extends the contingent-claims model of Fan and Sundaresan (2000) to account for this evidence, and derives testable implications on how these features relate to expected stock returns.…”

Resolution of financial distress under Chapter 11

“…Mella-Barral (1999) study private debt renegotiations when shareholders and creditors can alternatively make takeit-or-leave-it o¤ers. Fan and Sundaresan (2000) view renegotiations as a cooperative Nash bargaining game in which claimholders maximize renegotiations surplus to avoid costly liquidation. However, the assumption of a cooperative game for renegotiations may be harder to sustain for Chapter 11.…”

“…by backward induction from the last negotiation round, using (21), (16) and (17). Since the state space of the dynamic program is continuous, the …rst step is to partition it into a collection of convex subsets, and obtain a corresponding …nite set of grid points where the value functions are to be evaluated.…”