Debt Restructurings with Multiple Creditors

Abstract:     
We develop a model in which debt forgiveness can be Pareto- efficient because it improves incentives to invest. A debt restructuring plan, however, must be unanimously approved by a multiplicity of creditors who have private information about the liquidation value of the debtor. Using mechanism design, we show that too little debt forgiveness is granted in equilibrium, as expected. More interestingly, we find that exchange offers, similar to those used in US corporate debt workouts in the 1980s, are the optimal restructuring scheme for the debtor, as they allow creditors to contribute to debt forgiveness at different levels. Also, when creditors have correlated values they are more willing to offer debt forgiveness, and the debtor is better off. This is the opposite of the `winner's curse' phenomenon in auction theory.

JEL Classification: D82, G34, G33

working papers series