Debt overhang and non-distressed debt restructuring |
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| Institution: | 1. London School of Economics, Houghton Street, London WC2A 2AE, UK;2. Essex Business School, University of Essex, Wivenhoe Park, Colchester CO4 3SQ, UK;1. Tilburg University, Warandelaan 2, 5037 AB Tilburg, Netherlands;2. Stockholm School of Economics, CEPR and ECGI, PO Box 6501, Sveavagen 65, 11383 Stockholm, Sweden;1. Université Paris-Dauphine, PSL Research University, France;2. Université d’Orléans, LEO, UMR 7322, France;3. HEC Paris, France;1. Department of Business Administration, Athens University of Economics and Business, GR-14304, Athens, Greece;2. Department of Economics, University of Crete, GR-74100, Rethymno, Greece;1. University of Amsterdam, Netherlands;2. CEPR, United Kingdom;3. Olin Business School, Washington University in St. Louis, United States;4. ECGI, Belgium;1. Federal Reserve Board, 20th Street and Constitution, NW, 202-973-5047 (O), DC 20551, Washington;2. Federal Reserve Board, 20th Street and Constitution, NW, 202-721-4509 (O), DC 20551, Washington;3. Federal Reserve Board, 20th Street and Constitution, NW, 202-721-4517 (O), DC 20551, Washington;1. Department of International Trade, College of Business Administration, Gyeongsang National University, 501, Jinju-daero, Jinju-si, Gyeongsangnam-do, 52828, South Korea;2. Department of Business Administration, College of Business, Pusan National University, 2, Busandaehak-ro 63beon-gil, Geumjeong-gu, 46241, South Korea |
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| Abstract: | In this paper, we analyse the restructuring of debt in the presence of debt overhang. The firm starts out with a debt liability and an investment opportunity. Then with unrestructured debt, the firm maintains the current borrowing payments until default or investment. If the creditors allow the parties to restructure the debt with exchange offers, then the borrowing payments change as well as the default and investment points. We find that there is a unique optimal restructuring path which maintains debt at positive levels but defers default indefinitely. This path is optimal regardless of whether the debt holders or the firm control the process through superior bargaining power. Moreover, a debt-for-equity exchange to remove all existing debt takes place just before investment that is followed by the issue of an optimal amount of new debt as part of the funding for the investment cost. The optimal investment trigger is higher along the optimal restructuring path than it is for an unlevered firm. We discuss the findings in the light of existing empirical evidence. |
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