The impact of debt restructuring on dynamic investment and financing policies

Abstract

This paper explores the impacts of debt restructuring on investment and financing decisions and agency problem between shareholders and creditors. Notably, a critical feature in our model is that the renegotiation in debt restructuring is credible. To do so, we develop a unified model of dynamic investment, financing and agency problem for firms with renegotiable private debt, thereby highlight the significance of debt restructuring for corporate decisions. We find that firms with lower renegotiation costs and more uncertainty on cash flows are more likely to issue private debt than public debt. Interestingly, we also discover that debt restructuring can alleviate underinvestment and weaken sharesholders’ asset substitution motives, thereby reducing the agency costs of debt. The above results provide practical implications for policymakers about improving investment and financing efficiency and avoiding the deadweight loss of social welfare.