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Resolution of financial distress under agency frictions


Moreno, Santiago; Vo, Thi Quynh Anh (2017). Resolution of financial distress under agency frictions. Journal of Banking and Finance, 82:40-58.

Abstract

We introduce, in a dynamic-contracting framework with moral hazard, the possibility of recapitalization as an alternative to liquidation when a firm is distressed. This is achieved by considering a risk-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 distressed. This is achieved by considering a risk-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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3 citations in Scopus®
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Additional indexing

Item Type:Journal Article, refereed, original work
Communities & Collections:03 Faculty of Economics > Department of Banking and Finance
Dewey Decimal Classification:330 Economics
Scopus Subject Areas:Social Sciences & Humanities > Finance
Social Sciences & Humanities > Economics and Econometrics
Language:English
Date:1 September 2017
Deposited On:18 Feb 2020 16:44
Last Modified:28 Jul 2020 14:18
Publisher:Elsevier
ISSN:0378-4266
OA Status:Closed
Publisher DOI:https://doi.org/10.1016/j.jbankfin.2017.05.009
Related URLs:https://www.sciencedirect.com/science/article/pii/S037842661730119X (Publisher)
Other Identification Number:merlin-id:16946

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