PDF Ebook Conflicts in Bankruptcy and the Sequence of Debt issues
We present a model that shows how interactions between creditor groups in bankruptcy can affect the debt issuance decisions of firms. In particular, we suggest that deviations from APR should be priced and can affect the issuing decisions of junior and senior debt. Our model suggests that once firms issue debt with one level of seniority, they may have an incentive to alternate, and subsequent issues may have a different seniority level. When we introduce explicit costs of conflict in our model, we find that as these costs increase, firms will tend to stay with one class of debt. The empirical implications ofour model are consistent with the tendency of firms to alternate the seniority of debt issues, and with the somewhat surprising fact that some firms issue debt at one seniority level only, and quite a few of them never issue any senior debt. Finally, we study a sample of firms in bankruptcy and again find significant relationships between corporate characteristics and the types of debts that they issue, as predicted by the model.
Firms issue securities in sequence. In other words, when a new debt issue hits the market, the firm usually has several other issues outstanding already. The purpose of this paper is to model this sequential issuing process, taking into account a possible conflict between classes of debt with differing priorities should bankruptcy occur. Our theory explains several of the puzzling regularities observed in the issue data. We test some of our propositions using a fixed income database as well as a sample of firms in bankruptcy.
Our simple theory shows that conflicts during bankruptcy can make it optimal for a firm to alternate seniorities or issue senior debt only or junior debt only. When debt with different priorities is issued, we determine the optimal sequence of security issuance. The crux of our model is that, in the absence of frictions, the sequence of debt issues is irrelevant. However, if a firm needs to issue sequentially, the first issue may create incentives for a specific sequence.
We model the bankruptcy process as a conflict, where junior creditors can extract value from the senior creditors if the Absolute Priority Rule (APR) is violated. Once senior creditors price a potential conflict with junior creditors into their claims, it becomes optimal to issue junior debt next. Similarly, if junior debt is issued and priced first, the firm may find it optimal to subsequently issue senior debt. In equilibrium, creditors anticipate the firm's behavior and price claims taking into account the firm's best response. We extend the model to a situation when the bankruptcy conflict incurs dead weight costs, which can counteract incentives to issue a sequence of two different classes of debt.
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PDF Ebook Conflicts in Bankruptcy and the Sequence of Debt issues
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