Optimal Resolutions of Financial Distress by Contract

39 Pages Posted: 12 Jul 2006 Last revised: 26 Oct 2008

Nicola Gennaioli

Bocconi University - Department of Finance; Bocconi University - IGIER - Innocenzo Gasparini Institute for Economic Research

Stefano Rossi

Bocconi University; Krannert School of Management; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: June 2008

Abstract

In a financial contracting model, we characterize which debt structures can optimally resolve financial distress as a function of investor protection against tunneling. If investor protection is strong, the first best can be implemented under a debt structure consisting of two classes of debt: one that gives control upon default to a large creditor and induces him to internalize the upside of efficient reorganization, and a second, fully dispersed debt class without control rights. If instead investor protection is low, the second best can be implemented by dispersing control rights among creditors lending under standard "straight debt" contracts.
Floating charge financing successfully combines the features of our optimal debt structure in countries with strong investor protection and no restrictions to private contracting on bankruptcy.

Keywords: Corporate bankruptcy, Creditor Protection, Financial contracting

JEL Classification: G33, K22

Suggested Citation

Gennaioli, Nicola and Rossi, Stefano, Optimal Resolutions of Financial Distress by Contract (June 2008). Available at SSRN: https://ssrn.com/abstract=963587 or http://dx.doi.org/10.2139/ssrn.963587

Nicola Gennaioli

Bocconi University - Department of Finance ( email )

Via Roentgen 1
Milano, MI 20136
Italy

Bocconi University - IGIER - Innocenzo Gasparini Institute for Economic Research ( email )

Via Roentgen 1
Milan, 20136
Italy

Stefano Rossi (Contact Author)

Bocconi University ( email )

Via Roentgen 1
Milano, MI 20136
Italy

Krannert School of Management ( email )

West Lafayette, IN 47907-1310
United States

Centre for Economic Policy Research (CEPR) ( email )

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

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