Optimal Capital Structure and Bankruptcy Choice: Dynamic Bargaining vs Liquidation
79 Pages Posted: 6 Sep 2017 Last revised: 14 Jun 2018
Date Written: October 24, 2017
We model a firm’s optimal capital structure decision in a framework in which it may later choose to enter either Chapter 11 reorganization or Chapter 7 liquidation. Creditors anticipate equityholders’ ex-post reorganization incentives and price them into the ex-ante credit spreads. Using a realistic dynamic bargaining model of reorganization, we show that the off-equilibrium threat of costly renegotiation can lead to lower leverage, even with liquidation in equilibrium. If reorganization is less efficient than liquidation, the added option of reorganization can actually make equityholders worse off ex-ante, even when they liquidate on the equilibrium path.
Keywords: Capital Structure, Bankruptcy, Default, Dynamic Bargaining
JEL Classification: C73, C78, G31, G33
Suggested Citation: Suggested Citation