A Theory of Workouts and the Effects of Reorganization Law*

Robert H. Gertner · David S. Scharfstein

635 citations0/0 files storedThe Journal of Finance

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Corporate Insolvency and Governance Corporate Finance and Governance Financial Distress and Bankruptcy Prediction

Abstract

ABSTRACT We present a model of a financially distressed firm with outstanding bank debt and public debt. Coordination problems among public debtholders introduce investment inefficiencies in the workout process. In most cases, these inefficiencies are not mitigated by the ability of firms to buy back their public debt with cash and other securities‐the only feasible way that firms can restructure their public debt. We show that Chapter 11 reorganization law increases investment, and we characterize the types of corporate financial structures for which this increased investment enhances efficiency.

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References

1976Theory of the firm: Managerial behavior, agency costs and ownership structure 1984Corporate financing and investment decisions when firms have information that investors do not have 1986Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers 1977Determinants of corporate borrowing 1996Agency costs of free cash flow, corporate finance, and takeovers 1984The effect of capital structure on a firm's liquidation decision 1990The role of banks in reducing the costs of financial distress in Japan 1990Troubled debt restructurings

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1995Covenants and Collateral as Incentives to Monitor 2009Bankruptcy Codes and Innovation 1995Postbankruptcy Performance and Management Turnover 2002Coordination risk and the price of debt 1997Transactions Costs and Capital Structure Choice: Evidence from Financially Distressed Firms 1994A comparison of financial recontracting in distressed exchanges and chapter 11 reorganizations

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