Dynamic Runs and Optimal Termination
Posted: 10 Apr 2019
Date Written: March 19, 2019
Investors may fail to coordinate and run on distressed firms, which often forces those firms to terminate. How can firms design termination rules to promote coordination among investors? To address this question, we build a dynamic coordination model in which investors learn about a hidden bad shock in an asynchronous manner and then decide when to withdraw capital. The firm in the model can choose the termination threshold and clawback payments made to investors who withdraw within a certain window prior to its termination. Surprisingly, the firm can survive longer if it commits to terminate while there are still assets left for the remaining investors, because a higher termination payoff alleviates investors' ex-ante incentives to run. We analytically characterize the optimal clawback window and show that it should not be excessively long. A longer clawback window lowers the chance for an investor to exit the firm successfully, and therefore may lead investors to leave sooner.
Keywords: Dynamic Coordination, Debt Runs, Suspension of Redemption, Bankruptcy, Avoidable Preference
JEL Classification: D82, G33, G38
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