Mella-Barral, Pierre, "The Dynamics of Default and Debt Reorganization", Review of Financial Studies, Vol. 12, No. 3, (Fall 1999), pp. 535-578.
Abstract: This article documents the fact that when debtors decide on their obligations too early, it is in the creditors' collective interact, as residual claimants, to make concessions prior to forcing a costly liquidation. Symmetrically, when debtors prefer to default at an inefficiently late stage, it is in the creditors' interest to propose a departure from the absolute priority rule. This article develops a continuous time pricing model of dynamic debt restructuring that reflects the crucial influence of the two counterparties' relative bargaining power. Simple and intuitive path-dependent pricing formulae are derived for equity and debt. The debt capacity as well as the evolution of the firm's capital structure throughout its existence is provided.
Previously titled: The Dynamics of Corporate Debt forgiveness and Contract Renegotiation