Debt Renegotiation

Abstract

This paper develops a new model of debt renegotiation in a structural framework, that accounts for both taxes and bankruptcy costs. We investigate situations where the manager can optimally (on behalf of the equity holder) impose a permanent coupon reduction to creditors, given that the new coupon is chosen such that debt value remains constant. Our result shows that the manager designs the offer as a “take it or leave it” offer and that one can increase the financial value of the firm without hurting the creditors. This model of debt renegotiation can be viewed as a way of passing from a junk bond to an investment grade bond.

Keywords: Debt renegotiation, Debt pricing

JEL Classification: G30, G32, G33, G13