Efficient Recapitalization

Abstract

We analyze public interventions to alleviate debt overhang among private firms when the government has limited information and limited resources. We compare the efficiency of buying equity, purchasing existing assets, and providing debt guarantees. With symmetric information, all the interventions are equivalent. With asymmetric information between firms and the government, buying equity dominates the two other interventions. We solve for the optimal intervention, and show how it can be implemented with subordinated loans and warrants.

Keywords: bailout, capital, financial crisis, moral hazard

JEL Classification: G3, G34