Hongda Zhong - December 31, 2016
Firms often choose to raise capital from multiple creditors even though doing so may lead to inefficient liquidation caused by coordination failure. Potential coordination failure can, however, improve a firm’s incentive to repay its debt, thus increasing its debt capacity. Given this trade-off between higher liquidation risk and enhanced pledgeability, it is important to understand how firms choose the number of creditors and how this decision changes over time. I build a dynamic rollover model to analyze these questions. Consistent with empirical findings, I show that firms optimally increase the number of creditors when they perform badly. Even though having more creditors increases the liquidation probability, allowing for potential coordination failure from multiple creditors is valuable. Policies that commit the creditors to ex post efficient coordination exacerbate rollover difficulty and the reduction in firm value ex ante. Finally, if the firm can renegotiate its debt very frequently, the extra pledgeability from multiple creditors diminishes. The model also generates empirical implications for the firm value, the interest rates, and the probabilities of liquidation, renegotiation, and default.