The Design of Corporate Debt Structure and Bankruptcy

This paper integrates the problem of designing corporate bankruptcy rules into a theory of optimal debt structure. We show that, in an optimal contracting framework with imperfect renegotiation, having multiple creditors increases a firm’s debt capacity while increasing its incentives to default strategically. The optimal debt contract gives creditors claims that are jointly inconsistent in case of default. Bankruptcy rules, therefore, are a necessary part of the overall financing contract, to make claims consistent and to prevent a value reducing run for the assets of the firm. We characterize these rules, with pre-