Resolution of financial distress under Chapter 11

We develop a contingent claims model for a firm in financial distress with a formal account for renegotiations under the U.S. bankruptcy procedure (known as Chapter 11). Shareholders and two classes of creditors (senior and junior) alternatively propose a reorganization plan subject to a vote. The bankruptcy judge can intervene in any renegotiation round to impose a plan. The multiple-stage bargaining process is solved in a non-cooperative game-theory setting. The calibrated model yields the liquidation rate, the duration of Chapter 11 and the frequency of deviations from the Absolute Priority Rule, which are consistent with empirical evidence.