Implications of Debt Renegotiation for Optimal Bank Policy and Firm Behavior

Cited 0 time in webofscience Cited 0 time in scopus
Cho, Joonmo; Nakibullah, Ashraf
Issue Date
Seoul Journal of Economics
Seoul Journal of Economics 9 (No. 1 1996): 63-86
borrower and lendermoral hazardPareto-improvement
This paper analyzes the problems associated with the renegotiation of debt contracts involving a bank (the lender) and a firm (the borrower) when the latter is operated by a risk averse manager. Firms undertake risky projects with loan capital borrowed from the bank. When a firm cannot pay off a loan it is technically bankrupt. Both the borrower and the lender may experience a Pareto-improvement in their positions by renegotiating the loan. By renegotiating the terms of the debt the financially distressed firm can avoid the stigmatization of bankruptcy and the bank can avoid the costs of seizing the borrower's assets. However, our main finding is that, from the bank's point of view, renegotiation as a policy of recovering loan payments may be inefficient in practice because of a) false bankruptcy claims and b) moral hazard problems associated with exposure or the firm to the risk of default. We present a solution to the false bankruptcy claim problem that involves a mixed strategy between asset seizure by the bank and debt renegotiation. We also discuss the of collateral under the mixed strategy.
Files in This Item:
Appears in Collections:
College of Social Sciences (사회과학대학)Institute of Economics Research (경제연구소)Seoul Journal of EconomicsSeoul Journal of Economics vol.09(1) (Spring 1996)
  • mendeley

Items in S-Space are protected by copyright, with all rights reserved, unless otherwise indicated.