Game theoretic analysis of negotiations under bankruptcy

We extend the contingent claims framework for the levered firm in explicitly modelling the resolution of financial distress under formal bankruptcy as a non-cooperative game between claimants under the supervision of the bankruptcy judge. The identity of the class of claimants proposing the first reorganization plan is found to be a key determinant of the time spent under bankruptcy, the likelihood of liquidation and the renegotiated value of claims. Our quantitative results confirm the economic intuition that a bankruptcy design must trade-off the initial priority of claims with the viability of reorganized firms.

► We model the resolution of financial distress as a non-cooperative dynamic game. ► Claimants negotiate under the supervision of the bankruptcy judge in successive rounds. ► We find that the outcome depends on the sequence of players proposing a reorganization plan. ► We find that bankruptcy designs trade-off the priority of claims with the viability of firms.