On debt service and renegotiation when debt-holders are more strategic |
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| Institution: | 1. INRA - Economie Publique, 16 rue Claude Bernard, Paris, France;2. Ecole Polytechnique, Department of Economics, Palaiseau, France;3. HEC Montreal, 3000, Chemin Cote-Ste-Catherine, Room 4454, Montreal (Qc), Canada H3T 2A7;1. Research Department, Financial Stability Wing, Norges Bank (Central Bank of Norway), Bankplassen 2, P.O. Box 1179 Sentrum, 0107 Oslo, Norway;2. Market Infrastructure Division, Financial Stability, Bank of England, Threadneedle Street, London EC2R 8AH, United Kingdom;1. Laboratoire MSSMat, CNRS UMR 8579, Ecole Centrale Paris, Grande Voie des Vignes, 92290 Châtenay-Malabry, France;2. Innovation et Recherche SNCF, 40, avenue des Terroirs de France, 75611 Paris cedex 12, France;1. Institute of Earth Sciences, Academia Sinica, No. 128, Section 2, Academia Road, Nangang, Taipei 11529, Taiwan;2. Géoazur, 250 rue Albert Einstein, Les Lucioles 1, Sophia Antipolis, 06560 Valbonne, France;1. European Commission, Joint Research Centre, Institute for Transuranium Elements, P.O. Box 2340, D-76125 Karlsruhe, Germany;2. Helmholtz-Zentrum Dresden-Rössendorf (HZDR), Institute of Resource Ecology, P.O. Box 10119, 01314 Dresden, Germany;1. Department of Economics, Carleton University, Canada;2. School of Accounting and Finance, University of Waterloo, Canada;1. Arts et Métiers ParisTech, LEM3-UMR 7239 CNRS, 4 Rue Augustin Fresnel, 57078 Metz, France;2. Université de Lorraine, LEM3-UMR 7239 CNRS, Ile du Saulcy, 57045 Metz, France |
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| Abstract: | 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. |
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