We would like to thank Jan Ericsson, Jean Helwege and Franck Moraux for their useful comments. We also thank Ali Boudhina for excellent research assistance. Annabi and Breton acknowledge financial support from IFM 2 and NSERC. François acknowledges financial support from SSHRC.

Abstract:We develop a contingent claims model of a firm in financial distress with a formal account for renegotiations under the Chapter 11 bankruptcy procedure. Shareholders and two classes of creditors (senior and junior) alternatively propose a reorganization plan subject to a vote. The bankruptcy judge can intervene in any renegotiation round to impose a plan. The multiple-stage bargaining process is solved in a non-cooperative game theory setting. The calibrated model yields liquidation rate, Chapter 11 duration and percentage of deviations from the Absolute Priority Rule that are consistent with empirical evidence.

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Abstract:We extend the contingent claims framework for the levered firm in explicitly modeling the resolution of financial distress under formal bankruptcy as a non-cooperative game between claimants under the supervision of the bankruptcy judge. The identity of the class of claimants proposing the first reorganization plan is found to be a key determinant of the likelihood of liquidation and of the renegotiated value of claims. Our quantitative results confirm the economic intuition that a bankruptcy design must tradeoff the initial priority of claims with the viability of reorganized firms.

We extend the contingent claims framework for the levered firm in explicitly modeling the resolution of financial distress under formal bankruptcy as a non-cooperative game between claimants under the supervision of the bankruptcy judge. The identity of the class of claimants proposing the first reorganization plan is found to be a key determinant of the likelihood of liquidation and of the renegotiated value of claims. Our quantitative results confirm the economic intuition that a bankruptcy design must tradeoff the initial priority of claims with the viability of reorganized firms.

No abstract

This paper examines the reorganization process under Chapter 11 of the U.S. bankruptcy code. Our model considers two classes of creditors and accommodates several features of Chapter 11, including the intervention of the bankruptcy judge. We model the strategic interaction between claimants under Chapter 11 as a costly multiple-stage bargaining process, and solve it in a game theory setting. Using a structural framework, we extend the existing literature by generating reorganization and liquidation outcomes. We …nd that these outcomes are a¤ected by the characteristics of the …rm and of the negotiation game: the likelihood of liquidation increases with the probability of the bankruptcy judge intervention, asset volatility, length of negotiation process, and …nancial distress costs.

No abstract