Paper #1316

Title:

Contractual resolutions of financial distress

Authors:

Nicola Gennaioli and Stefano Rossi

Date:

November 2006 (Revised: May 2012)

Abstract:

In a financial contracting model, we study the optimal debt structure to resolve financial distress. We show that a debt structure where two distinct debt classes co-exist - one class fully concentrated and with control rights upon default, the other dispersed and without control rights - removes the controlling creditor's liquidation bias when investor protection is strong. These results rationalize the use and the performance of floating charge financing, debt financing where the controlling creditor takes the entire business as collateral, in countries with strong investor protection. Our theory predicts that the efficiency of contractual resolutions of financial distress should increase with investor protection.

Keywords:

Financial Distress, Investor Protection, Financial Contracting

JEL codes:

G33, K22

Area of Research:

Macroeconomics and International Economics

Published in:

The Review of Financial Studies, Forthcoming

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