This paper analyzes the problems associated with the renegotiation of debt contracts involving a bank (the lender) and a firm (the borrower) when the latter is operated by a risk averse manager. Firms undertake risky projects with loan capital borrowed from the bank. When a firm cannot pay off a loan it is technically bankrupt. Both the borrower and the lender may however experience a Pareto-improvement in their positions by renegotiating the loan. By renegotiating the terms of the debt the financially distressed firm can avoid the stigmatization of bankruptcy and the bank can avoid the costs of seizing the borrower's assets. However, our main finding is that, from the bank's point of view, renegotiating as a policy of recovering loan payments may be inefficient in practice because of false bankruptcy claims and moral hazard problems associated with exposure of the borrowing firm to the risk of default. We present a solution to the false bankruptcy claim problem that involves a mixe d strategy between asset seizure by the bank and debt renegotiation.
Review of Quantitative Finance and Accounting – Springer Journals
Published: Sep 29, 2004
It’s your single place to instantly
discover and read the research
that matters to you.
Enjoy affordable access to
over 18 million articles from more than
15,000 peer-reviewed journals.
All for just $49/month
Query the DeepDyve database, plus search all of PubMed and Google Scholar seamlessly
Save any article or search result from DeepDyve, PubMed, and Google Scholar... all in one place.
All the latest content is available, no embargo periods.
“Whoa! It’s like Spotify but for academic articles.”@Phil_Robichaud