Design and Valuation of Debt Contracts

REVIEW OF FINANCIAL STUDIES, Vol. 9 No. 1

Posted: 22 Aug 1998

See all articles by Ronald W. Anderson

Ronald W. Anderson

London School of Economics & Political Science - Department of Finance; Centre for Economic Policy Research (CEPR); Sun Yat-sen University (SYSU) - Xinhua College

Suresh M. Sundaresan

Columbia University - Columbia Business School, Finance

Abstract

This paper studies the design and valuation of debt contracts in a general dynamic setting under uncertainty. We incorporate some insights of the recent corporate finance literature into a valuation framework. The basic framework is an extensive form game determined by the terms of a debt contract and applicable bankruptcy laws. Debtholders and equityholders behave non-cooperatively. The firm's reorganization boundary is determined endogenously. Strategic debt service results in significantly higher default premia at even small liquidation costs. Deviations from absolute priority and forced liquidations occur along the equilibrium path. The design tends to stress higher coupons and sinking funds when firms have a higher cash payout ratio.

JEL Classification: G33

Suggested Citation

Anderson, Ronald W. and Sundaresan, Suresh M., Design and Valuation of Debt Contracts. REVIEW OF FINANCIAL STUDIES, Vol. 9 No. 1, Available at SSRN: https://ssrn.com/abstract=6854

Ronald W. Anderson

London School of Economics & Political Science - Department of Finance ( email )

Houghton Street
London WC2A 2AE
United Kingdom
+44 20 7955 6204 (Phone)
+44 20 7955 7420 (Fax)

HOME PAGE: http://personal.lse.ac.uk/ANDERSOR/

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Sun Yat-sen University (SYSU) - Xinhua College ( email )

China

Suresh M. Sundaresan (Contact Author)

Columbia University - Columbia Business School, Finance ( email )

3022 Broadway
New York, NY 10027
United States
212-854-4423 (Phone)
212-316-9180 (Fax)

HOME PAGE: http://www0.gsb.columbia.edu/faculty/ssundaresan/

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