Beware of creditors bearing opportunities?

Abstract

Bankruptcy is costly. However, we show that an opportunity to lower this cost is not necessarily good news when the opportunity is facilitated by an expert creditor, like a specialist hedge fund. The reason is a tension between leveraging the creditor's expertise to raise firm value and the creditor's desire to earn rents. To limit the rents, claimants can agree to outcomes that, while they shorten the time spent in bankruptcy, are inefficient and dissipate firm value. Our model show that the value dissipation tends to be greater when bankruptcy is more costly and when bankruptcy is more favorable to creditors.

Keywords: hedge fund, restructuring, bankruptcy, asset sales

JEL Classification: G33