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Agency problems, recapitalization costs and optimal resolution of financial distress


Moreno-Bromberg, Santiago; Vo, Quynh-Anh (2015). Agency problems, recapitalization costs and optimal resolution of financial distress. NCCR FINRISK Working Paper Series 861, University of Zurich.

Abstract

We introduce in a dynamic–contracting framework with moral hazard the possibility of recapitalization as an alternative to liquidation when a firm is in financial distress. This is achieved by considering a loss–averse agent and by allowing (but not requiring) the latter to inject additional capital into the firm when necessary. We show that firm recapitalization may arise in an optimal, long–term contract. As a consequence, we find that there are two mechanisms at a firm’s disposal so as to deal with financial difficulties: one corresponds to a recapitalization process, the other to a liquidation one. The choice of mechanism is based on a cost–benefit analysis.

Abstract

We introduce in a dynamic–contracting framework with moral hazard the possibility of recapitalization as an alternative to liquidation when a firm is in financial distress. This is achieved by considering a loss–averse agent and by allowing (but not requiring) the latter to inject additional capital into the firm when necessary. We show that firm recapitalization may arise in an optimal, long–term contract. As a consequence, we find that there are two mechanisms at a firm’s disposal so as to deal with financial difficulties: one corresponds to a recapitalization process, the other to a liquidation one. The choice of mechanism is based on a cost–benefit analysis.

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Additional indexing

Item Type:Working Paper
Communities & Collections:03 Faculty of Economics > Department of Banking and Finance
Dewey Decimal Classification:330 Economics
JEL Classification:D82, G32, G33
Language:English
Date:1 June 2015
Deposited On:03 Mar 2014 08:00
Last Modified:27 May 2016 13:47
Series Name:NCCR FINRISK Working Paper Series
Official URL:http://www.zora.uzh.ch/93705/
Other Identification Number:merlin-id:9272

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