Strategic Debt Service

When firms experience financial distress, equity holders may act strategically, forcing concessions from debtholders and paying less than the originally contracted interest payments. This article incorporates strategic debt service in a standard, continuous time asset pricing model, developing simple closed-form expressions for debt and equity values. The authors find that strategic debt service can account for a substantial proportion of the premium on risky corporate debt. They analyze the efficiency implications of strategic debt service, showing that it can eliminate both direct bankruptcy costs and agency costs of debt. Copyright 1997 by American Finance Association.

[1]  Sheridan Titman,et al.  The effect of capital structure on a firm's liquidation decision☆ , 1984 .

[2]  Eduardo S. Schwartz,et al.  Optimal Financial Policy and Firm Valuation , 1984 .

[3]  B. Dumas.  Super contact and related optimality conditions , 1991 .

[4]  F. Black,et al.  VALUING CORPORATE SECURITIES: SOME EFFECTS OF BOND INDENTURE PROVISIONS , 1976 .

[5]  David C. Mauer,et al.  Interactions of Corporate Financing and Investment Decisions: A Dynamic Framework , 1994 .

[6]  S. Myers.  Determinants of corporate borrowing , 1977 .

[7]  Alexander J. Triantis,et al.  An integrated model of multinational flexibility and financial hedging , 1995 .

[8]  H. Leland..  Corporate Debt Value, Bond Covenants, and Optimal Capital Structure , 1994, World Scientific Reference on Contingent Claims Analysis in Corporate Finance.

[9]  David M. Kreps,et al.  Martingales and arbitrage in multiperiod securities markets , 1979 .

[10]  Walter N. Torous,et al.  An Empirical Investigation of U.S. Firms in Reorganization , 1989, World Scientific Reference on Contingent Claims Analysis in Corporate Finance.

[11]  A. Rubinstein.  Perfect Equilibrium in a Bargaining Model , 1982 .

[12]  John Parsons,et al.  Measuring the Agency Cost of Debt , 1992 .

[13]  Suresh M. Sundaresan,et al.  Design and Valuation of Debt Contracts , 1994 .

[14]  Suresh M. Sundaresan,et al.  Does Default Risk in Coupons Affect the Valuation of Corporate Bonds?: A Contingent Claims Model , 1993 .

[15]  Jeffrey L. Callen,et al.  Opportunistic underinvestment in debt renegotiation and capital structure , 1991 .

[16]  A. Dixit.  Entry and Exit Decisions under Uncertainty , 1989, Journal of Political Economy.

[17]  R. C. Merton,et al.  On the Pricing of Corporate Debt: The Risk Structure of Interest Rates , 1974, World Scientific Reference on Contingent Claims Analysis in Corporate Finance.

[18]  Robert Heinkel,et al.  Dynamic Capital Structure Choice: Theory and Tests , 1989 .

[19]  Eduardo S. Schwartz,et al.  A Simple Approach to Valuing Risky Fixed and Floating Rate Debt , 1995 .