Optimal Capital Structure and Bankruptcy Choice: Dynamic Bargaining vs. Liquidation

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By Samuel Antill and Steven R. Grenadier (Stanford Graduate School of Business)

In this work, we develop and solve a continuous-time dynamic bargaining model of Chapter 11 reorganization. We include many features of the Chapter 11 process, such as the automatic stay, suspension of dividends, the exclusivity period, post-exclusivity proposals by creditors, and the potential for forced conversion to Chapter 7. The reorganized firm may issue new debt and continue operating. Moreover, both debtors and creditors face uncertainty over future asset values as they debate reorganization plans. We solve for the equilibrium and the corresponding expected payoffs to creditors and equityholders.

Using this equilibrium, we proceed to model a firm’s optimal capital structure decision in a framework in which the firm may later choose to enter either Chapter 11 reorganization or Chapter 7 liquidation. Creditors anticipate equityholders’ future reorganization incentives and price them into credit spreads when the debt is issued (ex ante). The implied capital structure results in both higher credit spreads and dramatically lower leverage than existing models suggest. Giving creditors more bargaining power in bankruptcy typically leads to higher leverage and ex ante firm value, consistent with empirical evidence. If reorganization is less efficient than liquidation, the added option of reorganization can actually make equityholders worse off ex ante, even if the firm is eventually liquidated.

The full article is available here.

Debt Structure as a Strategic Bargaining Tool

By Yue Qiu, University of Minnesota (will join Temple University as Assistant Professor of Finance on August 1st, 2017)

In this paper, I study the strategic role of debt structure in improving the bargaining position of a firm’s management relative to its non-financial stakeholders. Debt structure is essential for strategic bargaining between management and non-financial stakeholders because it affects the ease of renegotiating debt contracts and thus the credibility of bankruptcy threats. Debt structure, not necessarily debt level, is shown to be adjusted as a response to an increase in non-financial stakeholders’ negotiation power.

Using NLRB labor union elections as a laboratory setting and employing a regression discontinuity design, I find that passing a labor union election leads to larger creditor dispersion in a firm’s outstanding debt. In particular, union certification leads to an increase in the ratio of public debt to total assets and a decrease in the ratio of bank debt to total assets in the following three years after elections, whereas there is no significant change in the level of total debt. Moreover, the syndication size of newly issued bank loans increases while creditor ownership concentration decreases once the vote share for unions passes the winning threshold.

Further analyses confirm that the debt structure adjustments after union certification are more likely driven by strategic concerns of management rather than more constrained access to bank loans. Finally, I also show that the degree of wage concessions is strongly related to a firm’s debt structure using the airline industry as an empirical setting.

The full paper is available here.