Dynamic Runs and Optimal Termination

Posted: 10 Apr 2019

See all articles by Hongda Zhong

Hongda Zhong

London School of Economics & Political Science (LSE) - Department of Finance

Zhen Zhou

Tsinghua University - PBC School of Finance

Date Written: March 19, 2019

Abstract

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

Suggested Citation

Zhong, Hongda and Zhou, Zhen, Dynamic Runs and Optimal Termination (March 19, 2019). Available at SSRN: https://ssrn.com/abstract=3355429

Hongda Zhong

London School of Economics & Political Science (LSE) - Department of Finance ( email )

United Kingdom

Zhen Zhou (Contact Author)

Tsinghua University - PBC School of Finance ( email )

No. 43, Chengdu Road
Haidian District
Beijing 100083
China

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