Repeated Dilution of Diffusely Held Debt

• Published in: The Journal of business (Chicago, Ill.) Vol. 78; no. 3; pp. 737 - 786
• Main Authors: Hege, Ulrich, Mella‐Barral, Pierre
• Format: Journal Article
• Language: English
• Published: Chicago The University of Chicago Press 01-05-2005; University of Chicago, acting through its Press; University of Chicago Press
• Subjects: Bargaining; Business administration; Business management; Company insolvency; Contracts; Coupons; Credit co-operatives; Credit systems; Creditors; Creditors rights; Debt; Debt contracts; Debt management; Debt repayment; Dilution; domain_shs.gestion.fin; Economic models; Exchange offers; Financial assets; Financial management; Humanities and Social Sciences; Liquidation value; Public debt; Secured debt; Shareholders; Studies; Tariff negotiations; Debt Pricing; Multiple Creditors; Debt Reorganization; Priority of Claims
• ISSN: 0021-9398; 1537-5374
• DOI: 10.1086/429643

Debt with many creditors is analyzed in a continuous‐time pricing model of the levered firm with opportunistic renegotiation offers and default threats. Dispersed creditors accept coupon concessions only in exchange for guaranteed liquidation rights, like collateral. In the ex ante optimal debt contract, this security is provided by assets that gradually become worthless as the firm approaches the preferred liquidation conditions. Dispersed debt offers larger debt capacity than single‐creditor debt and is preferable if the ex ante value of collateralizable assets is sufficiently low. Our model explains credit risk premia in excess of those supported by a single creditor with opportunistic renegotiation.