Dynamic bankruptcy procedure with asymmetric information between insiders and outsiders

Abstract

We develop a dynamic model in which a distressed firm optimizes the bankruptcy choice and its timing. When the distressed firm's shareholders sell the assets, they are better informed about the asset value than outsiders are. We show that this asymmetric information can delay the asset sales to signal asset quality to outsiders. More debt and lower asset value can reduce the signaling cost and mitigate the asset sales delay. Notably, we show that the firm changes the bankruptcy choice from selling out to liquidation bankruptcy when the signaling cost associated with selling out is high. This distortion in the bankruptcy choice greatly lowers the debt value, whereas it has a weak impact on the equity value.

Liquidation, fire sales, and acquirers’ private information

“…Proposition 1 agrees with Proposition 1 in Nishihara and Shibata (2018) for τ = 0, while it corresponds to the standard solution in Mella- Barral and Perraudin (1997) for τ = a i = 0. The default case agrees with the standard solution in Goldstein, Ju, and Leland (2001).…”

“…The default case agrees with the standard solution in Goldstein, Ju, and Leland (2001). As in Mella- Barral and Perraudin (1997), Lambrecht and Myers (2008), and Nishihara and Shibata (2018), Proposition 1 shows that shareholders prefer to sell out for low debt levels compared to asset value, while they prefer to default for high debt levels compared to asset value. Naturally, the sell-out region is wider for a high-value type than for a low-value type (cf.…”

“…As in Mella- Barral and Perraudin (1997), Lambrecht and Myers (2008), Nishihara and Shibata (2017), and Nishihara and Shibata (2018), shareholders of the distressed firm choose between sell-out and default, its timing, and the offer price in the sell-out case in 6 The model is more relevant to target-initiated deals than acquirer-initiated deals. Masulis and Simsir (2015) show that targets in financial distress are likely to initiate transactions than in normal times.…”

“…Equity value (8) can be derived in the same manner as Proposition 1 in Nishihara and Shibata (2018). First, we solve problem (8) with s i = 1.…”

“…Shareholders, who observe dynamic and stochastic changes in a distressed firm's cash flows, optimize an exit choice between sell-out and default as well as its timing. 2 The model does not distinguish between shareholders and managers, assuming that 1 Nishihara and Shibata (2018) show that a distressed firm's private information about asset quality can delay asset sales to signal asset quality. Contrary to the previous paper, this paper assumes the counterparty's private information.…”