Liquidity and Liquidation |
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Authors: | David L Kelly Stephen F LeRoy |
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Institution: | (1) Department of Economics, University of Miami, Box 248126, Coral Gables, FL 33143, USA;(2) Department of Economics, University of California, Santa Barbara, CA 93106, USA |
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Abstract: | The manager of a firm that is selling an illiquid asset has discretion as to the sale price: if he chooses a high (low) selling
price, early sale is unlikely (likely). If the manager has the option to default on the debt that is collateralized by the
illiquid asset, the optimal selling price depends on whether the manager acts in the interests of owners or creditors. We
model the former case. In equilibrium the owner will always offer the illiquid asset for sale at a strictly higher price than
he paid, and will default if he fails to sell. As a result, upon successful sales the illiquid asset changes hands at successively
higher prices. We also consider a generalization of the model which permits sellers to finance sales using either debt or
preferred stock, or both. This allows derivation of an optimal capital structure.
We are indebted to seminar participants at the University of California, Los Angeles; University of California, Santa Barbara;
Utah State University; University of Miami; Federal Reserve Bank of Atlanta; Federal Reserve Bank of San Francisco and Federal
Reserve Bank of Kansas City. We have received helpful comments from Tom Cooley. |
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Keywords: | Illiquidity Liquidation Illiquid asset Bankruptcy costs Optimal capital structure Agency costs Asset pricing Search |
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