Optimal Capital Structure and Bankruptcy Choice: Dynamic Bargaining vs Liquidation

79 Pages Posted: 6 Sep 2017 Last revised: 14 Jun 2018

See all articles by Samuel Antill

Samuel Antill

Stanford Graduate School of Business

Steven R. Grenadier

Stanford Graduate School of Business

Date Written: October 24, 2017

Abstract

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

Antill, Samuel and Grenadier, Steven R., Optimal Capital Structure and Bankruptcy Choice: Dynamic Bargaining vs Liquidation (October 24, 2017). Stanford University Graduate School of Business Research Paper No. 17-59. Available at SSRN: https://ssrn.com/abstract=3030978 or http://dx.doi.org/10.2139/ssrn.3030978

Samuel Antill (Contact Author)

Stanford Graduate School of Business ( email )

Stanford, CA 94305
United States

Steven R. Grenadier

Stanford Graduate School of Business ( email )

Graduate School of Business
Stanford, CA 94305-5015
United States
650-725-0706 (Phone)
650-725-6152 (Fax)

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