Disagreement and Capital Structure Complexity

33 Pages Posted: 27 Nov 2018 Last revised: 13 Mar 2019

See all articles by Kenneth Ayotte

Kenneth Ayotte

University of California, Berkeley - School of Law

Date Written: February 1, 2019


In the post-financial crisis period, many corporate bankruptcies involve complicated, fragmented capital structures characterized by many layers of debt and complex legal entity structures with many subsidiaries. Why do capital structures evolve this way, given that they make distress more costly to resolve? I suggest an answer based on the notion that investors may disagree about the value of assets that back loans. When such disagreement exists, firms have the incentive to exploit it by issuing claims that are targeted to subsets of the assets that investors are more optimistic about. This capital structure fragmentation can minimize the borrower's cost of funds ex-ante by maximizing creditors' perceived recoveries, but it can be socially inefficient, because it creates costly valuation disputes in bankruptcy. I show that disagreement about collateral values can cause inefficient liquidations. I also find that reorganizations, in which pre-bankruptcy creditors receive securities in the ongoing firm, allows parties to continue "agreeing to disagree" about the value of their entitlements. This can promote settlement and reduce costly litigation over valuation, relative to selling the firm as a going concern for cash.

Keywords: bankruptcy, capital structure, disagreement, valuation, subsidiaries

JEL Classification: G32, G33, K22

Suggested Citation

Ayotte, Kenneth, Disagreement and Capital Structure Complexity (February 1, 2019). Available at SSRN: https://ssrn.com/abstract=3276779 or http://dx.doi.org/10.2139/ssrn.3276779

Kenneth Ayotte (Contact Author)

University of California, Berkeley - School of Law ( email )

215 Boalt Hall
Berkeley, CA 94720-7200
United States

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