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Rev Fin 2000; 13:1057-1099
© 2000 the Society for Financial Studies

Article

Debt valuation, renegotiation, and optimal dividend policy

H Fan1 and SM Sundaresan2,z
1 Columbia University and Goldman Sachs
2 811 Uris Hall, 3022 Broadway, Graduate School of Business, Columbia University, New York, NY 10027, USA
z Corresponding author
E-mail: ms122@columbia.edu

Abstract

The valuation of debt and equity, reorganization boundaries, and firm's optimal dividend policies are studied in a framework where we model strategic interactions between debt holders and equity holders in a game-theoretic setting which can accommodate varying bargaining powers to the two claimants. Two formulations of reorganization are presented: debt-equity swaps and strategic debt service resulting from negotiated debt service reductions. We study the effects of bond covenants on payout policies and distinguish liquidity-induced defaults from strategic defaults. We derive optimal equity issuance and payout policies. The debt capacity of the firm and the optimal capital structure are characterized.


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