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A Continuous-Time Analysis of Optimal Restructuring of Contracts with Costly Information Disclosure

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Abstract

This paper studies the role of restructuring, as compared to the one of liquidation, in valuation of long-term debt contracts in a continuous-time model with costly information disclosure. In asset-pricing literature, Merton’s (J Finance 29:449–470, 1974) contingent-claim models have been long used for valuation of corporate securities and loans. However, since they basically assume sufficiently complete security structures in markets, the literature is not necessarily suitable for examining costly-information problems. On the other hand, in corporate-finance literature, it has been well known that agency costs (i.e., conflicts of interest among agents) distort corporate capital structure under costly-information problems. However, the effect of the distortion on valuation of securities and loans has not been explicitly studied either in theory or in practice. This paper bridges such a gap between the two literatures. This paper shows that, under a costly-information problem, corporate leverage ratios are higher when restructuring is expected to be accepted in default than otherwise. The risk of a jump to liquidation increases the default probability in short term, and decreases the probability of restructuring over time.

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Authors and Affiliations

  1. Graduate School of Commerce and Management, Hitotsubashi University, 2-1 Naka, Kunitachi City, Tokyo, 186-8601, Japan

    Hisashi Nakamura

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  1. Hisashi Nakamura
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Correspondence to Hisashi Nakamura.

Additional information

This paper is an extension of my Ph.D thesis. Previously, it was entitled “A Continuous-Time Analysis of Optimal Contracts under Costly State Verification: Theory and Applications.” I would like to thank Ed Green and Akihiko Takahashi for his constant encouragement and advice throughout the preparation of this work. I would also like to thank Lars Peter Hansen, Milton Harris, and Shigeo Kusuoka for their help at various stages. I am also thankful to the anonymous referee and Joshua Aizenman, Alessandro Barbarino, Javier Birchenall, Toni Braun, Marco Cagetti, Sean Campbell, Dan Friedman, Ricard Gil, Erik Heitfield, Tokuo Iwaisako, Michihiro Kandori, Jinill Kim, Yong Jin Kim, Ken Kletzer, Hyeng Keun Koo, Andy Levin, Jeffrey Marquardt, Travis Nesmith, Kazuhiko Ohashi, Shige Peng, Matthew Pritsker, Akihiko Matsui, Makoto Saito, Jun Sekine, Jaeyoung Sung, Carl Walsh, Egon Zakrajšek, and all seminar participants at 10th Econometric Society World Congress (Shanghai), 10th SAET Conference on Current Trends in Economics (Singapore), the 2007 Annual meetings of the Society for Economic Dynamics (Prague), the 2007 North American Summer Meeting of the Econometric Society (Duke University), the 2006 Nippon Finance Association annual meetings, Ajou University, Federal Reserve Board of Governors, Hitotsubashi University, Kyoto University, University of California, Santa Cruz, University of Tokyo, and Tokyo Finance Workshop for their comments. I am thankful to Roger Smith for editing assistance.

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Nakamura, H. A Continuous-Time Analysis of Optimal Restructuring of Contracts with Costly Information Disclosure. Asia-Pac Financ Markets 19, 119–147 (2012). https://doi.org/10.1007/s10690-011-9144-6

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