Debt Valuation, Renegotiations, and Optimal Dividend Policy

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Abstract
The valuation of debt and equity, reorganization boundaries and firm's 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 debtholders and equityholders 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. Bond covenants lead to more conservative dividend policies which benefit both claimants via lowered expected cost of liquidation. We derive optimal equity issuance and dividend policies. The debt capacity of the firm and the optimal capital structure are characterized.
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