Repeated Dilution of Diffusely Held Debt

Posted: 7 Mar 2007

See all articles by Ulrich Hege

Ulrich Hege

Toulouse School of Economics; European Corporate Governance Institute (ECGI)

Pierre Mella-Barral

Toulouse Business School

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Debt with many creditors is analyzed in a continuous-time pricing model of the levered firm in the presence of corporate taxes. We specifically allow for debtor opportunism in form of repeated strategic renegotiation offers and default threats. Dispersed creditors will only accept coupon concessions in exchange for guaranteed liquidation rights, e.g. collateral. The ex ante optimal debt contract is secured with assets which gradually become worthless as the firm approaches the preferred liquidation conditions, in order to allow for sufficient, but delayed renegotiability. Compared with single-creditor debt, dispersed debt offers a larger debt capacity, and it is preferable ex-ante if the value of collateralizable assets is then reduced. Our model can explain credit risk premia in excess of those supported by a single creditor model with opportunistic renegotiation.

Keywords: Debt Reorganization, Multiple Creditors, Priority of Claims, Debt Pricing

JEL Classification: G12, G32, G33

Suggested Citation

Hege, Ulrich and Mella-Barral, Pierre, Repeated Dilution of Diffusely Held Debt. Journal of Business, Vol. 78, No. 3, 2005. Available at SSRN:

Ulrich Hege (Contact Author)

Toulouse School of Economics ( email )

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European Corporate Governance Institute (ECGI)

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Pierre Mella-Barral

Toulouse Business School ( email )

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Toulouse, 31068

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