Resolution of financial distress under Chapter 11

Abstract

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.

Cost of Debt and Corporate Profitability

“…Since the seminal works of Beaver (Beaver, 1966; and Altman (Altman, 1968), a large volume of studies have analyzed the characteristics of firms in order to predict the state of crisis (for a literature review see Mansi, Maxwell, & Zhang, 2012;Aziz & Dar, 2006;Dimitras, Zanakis, & Zopounidis, 1996;Guoquiang et al, 1999;Keasey & Watson, 1991) and the resolution measures that can be taken to overcome financial and/or economic difficulties (for recent studies see Brown, Ciochetti, & Riddiough, 2006;Hotchkiss et al, 2008;Annabi, Breton, & François, 2012). Without going into a detailed examination of this vast subject, two main interrelated causes of corporate crisis emerge quite clearly.…”

Insolvent trading and voluntary administration in Australia: economic winners and losers?

“…The bargaining between creditors and equity holders over debt indenture terms is complicated, and beyond the scope of our simple model. Other authors have explored simplified bargaining scenarios within continuous time framework (Anderson and Sundaresan, ; Annabi et al ., ); however, it would be difficult to accommodate directors–creditors bargaining using the entire insolvent trading and voluntary administration decision tree.…”

“…Contingent claims models are a well‐accepted approach to explore agent behaviour under various scenarios. Such models have been used to analyse creditor‐equity holder bargaining (Anderson and Sundaresan, ; Annabi et al ., ), entrepreneurial decision‐making (McGrath, ; O'Brien et al ., ) and optimal project abandonment (Myers and Majd, ), among other applications.…”

Bond Exchange Offers or Collective Action Clauses?

“…6 The relationship between out-of-court renegotiation and Chapter 11-style reorganization is addressed in White (1994) andvon Thadden, Berglöf, andRoland (2010). Annabi, Breton, and François (2012) analyze bargaining with different classes of debt during bankruptcy.…”