Investment Decisions, Debt Renegotiation Friction, and Agency Conflicts

Published date01 June 2020
DOIhttp://doi.org/10.1111/irfi.12208
Date01 June 2020
AuthorHwa‐Sung Kim
Investment Decisions, Debt
Renegotiation Friction, and Agency
Conicts*
HWA-SUNG KIM
School of Management, Kyung Hee University, Seoul, South Korea
ABSTRACT
This paper investigates how investment decisions are inuenced by the pos-
sibility of debt renegotiation failure and shareholderdebtholder conicts by
extending the Sundaresan and Wang (2007) model. We nd that the differ-
ence in investment thresholds due to agency conicts decreases as share-
holdersbargaining power increases. We also show that as the probability of
renegotiation friction is lower, the investment threshold is lower, which is
consistent with the empirical result of Favara et al. (2017).
JEL Codes: D81; G31; G33
Accepted: 29 May 2018
I. INTRODUCTION
Financially distressed rms are more likely to renegotiate debt privately before
ling a Chapter 11 bankruptcy in the court (Gilson et al. 1990). However, as
stated in Davydenko and Strebulaev (2007), empirical studies nd that one-half
of rms that attempt debt renegotiation ultimately le for bankruptcy. Accord-
ing to the empirical literature, this possibility of renegotiation failure or renego-
tiation friction is an important factor when explaining rm characteristics in a
country or across countries.
1
Partial examples of this literature include Davy-
denko and Strebulaev (2007) on corporate debt spreads of the U.S. rms, Favara
et al. (2012) on equity beta, and Favara et al. (2017) on investment across
countries.
In line with the empirical literature on renegotiation friction, this paper
examines how a rms investment decision is inuenced by debt renegotiation
friction and agency conicts. Our paper relates to the literature on the presence
* I would like to thank the anonymous reviewer and Ramazan Gençay (the editor) for their valu-
able comments. Part of this paper was written while the author was visiting the Paul Merage School
of Business, University of California, Irvine. This work was supported by a grant from Kyung Hee
University in 2015 (KHU-20151259).
1 Renegotiation friction is also referred to as an imperfect debt enforcement in Favara
et al. (2017).
© 2018 International Review of Finance Ltd. 2018
International Review of Finance, 20:2, 2020: pp. 493504
DOI: 10.1111/ir.12208

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