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In Rememberance: World Trade Center (WTC)

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Debt Valuation, Renegotiation, and Optimal Dividend Policy

by Hua Fan of Columbia University and Goldman Sachs, and
Suresh M. Sundaresan of Columbia University

Winter 2000

Abstract: The valuation of debt and equity, reorganizations 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.

Published in: Review of Financial Studies, Vol.13, No.4, (Winter 2000), pp. 1057-1099.

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