Contractual Resolutions of Financial Distress
Centro di Ricerca sull'Economia delle Istituzioni (CREI) (Research Center on Economics of Institutions)
Krannert School of Management; Centre for Economic Policy Research (CEPR)
July 5, 2009
In a financial contracting model we study the optimal debt structure to resolve financial distress. We show that a debt structure where two distinct debt classes co-exist - one class fully concentrated and with control rights upon default, the other dispersed and without control rights - removes the controlling creditor's liquidation bias when investor protection is strong. These results rationalize the use and the performance of floating charge financing, debt financing where the controlling creditor takes the entire business as collateral, in countries with strong investor protection. More broadly, our theory predicts that the efficiency of contractual resolutions of financial distress should increase with investor protection.
Number of Pages in PDF File: 50
Keywords: Financial Distress, Investor Protection, Financial Contracting
JEL Classification: G33, K22working papers series
Date posted: March 25, 2008 ; Last revised: October 29, 2009
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