Seminar with Johann Reindl, Vienna Graduate School of Finance (VGSF)
Upcoming Finance Seminar with Johann Reindl, Vienna Graduate School of Finance (VGSF)
Title: Deleveraging Via Asset Sales: Agency Costs, Taxes, and Government Policies
Do equityholders of a financially distressed firm have an incentive to sell assets and buy back debt to achieve a more sustainable leverage ratio and avoid costly bankruptcy? I develop a dynamic structural model incorporating a dynamic game to determine conditions under which a firm would voluntarily do so. It allows me to assess the impact of debt overhang and asset substitutionon the restructuring condition and the holdout problem. I find that as long as the total firm value increases through the debt repurchase, equityholders benefit from it, as well. In a dynamic setting, the debt overhang problem takes the form of too early restructuring. Taxes on cancellation of debt income and government subsidies to debtholders can destroy equityholders’ incentives; so does low liquidity in the market for the firm’s assets; an asset purchase program fosters them. Finally, via threatening not to tender, debtholders can appropriate a large share of the firm’s restructuring gains. However, they cannot stop equityholders from gambling for resurrection which in turn gives equityholders bargaining power to prevent debtholders from holding out.