Research On The Incentive-compatible Approaches And Pricing For Dealing With Corporation Debt Overhang

Debt overhang makes the corporation fall into the financial distress,and makes it hard for the corporation to finance or invest normally in the market.The key point of dealing with debt overhang is to recapitalize which means to adjust the capital structure of the corporation.But debt overhang can prevent the corporation from external financing and ruduce the willingness of shareholders to improve the business condition.Therefore,this paper proposes to reset the claims incentive-compatibily based on the coordination of the stakeholders to adjust the corporation capital structure for dealing with debt overhang.The incentive-compatible approaches for dealing with debt overhang are designed in ex-post and ex-ante two types after and before debt overhang happens.They are the ex-post approaches based on the debt renegotiation and the ex-ante approaches based on the products with automatic debt-to-equity triggers.The incentive-compatible theory of ex-post approaches reflects in coordinating the stakeholders,and relocating the claims based on the Pareto improvement.The incentive-compatible theory of ex-ante approaches reflects in adjusting the risk premiums of the products with automatic debt-to-equity triggers and then giving the holders reasonable risk compensations.The details of the ex-post solutions are that:after the corporation falls into the financial distress caused by debt overhang,the shareholders and the debtholders renegotiate for a debt service plan through the debt renegotiation in order to reset their claims incentive-compatibily,and then adjust the corporation capital structure.The details of the ex-ante solutions are that:the corporation issues the Contingent Convertible Bonds(CoC.os for short)style financial product to partially substitute the senior debt when they are financing from the debt issuance in order to adjust the corporation capital structure by auto-triggered CoC.os conversion when the corporation falls into the financial distress caused by debt overhang.The pricing models of the stakeholders' claims are built and solved by using and improving the structural credit risk pricing approach in the perspective of corporations(debtors).The influence factors and their risk implications of the pricing models are given by the numerical simulations based on the pricing results.The main research achievements are summarized as follows:(1)This research achievement provides an ex-post approach combing "cash plus shares”style mixed-payoff and the debt renegotiation for dealing with debt overhang.It can reduce the negative effects of the single-payoff.The HJB(Hamilton-Jacobi-Bellman)equation is used to solve the mixed-payoff ratio under the optimal asset allocation.The pricing models of the stakeholders' claims are built and solved by using the structural credit risk pricing approach.When the corporation is dealing xwith debt overhang through the debt renegotiation.the single payoff method can make many negative etffects:the debt-to-equity style debt payoff method can cause equity dilution and make the debtholders face great uncertains,directly debt callback can cause great liquidity pressures.these are bad for the process of the negotiation.Satisf'yin.g the debtholders' risk preference is conducti-ve to the debt renegotiation.Therefore.this research provides a mixed-payoff method to pay off the debt with shares and cash for promoting the single debt payoff styles.The debtholders' risk preference is described by CRRA utility function,the debt-holders' asset allocation optimation problem is solved by the H.JB equation,the asset realization cost is introduced.and then the process of Nash bargaining g'ame model is promoted.At last,the pricing problems are solved by the structural credit risk pricing approach and the explicit solutions of the stakeholders' claim vaIlues are given,and then the risk implications of the parameters are ex plored based on the numerical simulation.The results show that:this research achievement can reduce the negative effects of the single debt payoff styles and improve the ef'ficiency of the ex-post debt renegotiations.(2)This research achievement gives numerical analysis to how the economic cycle factor and the corporation operation factor shock the EBIT,and it develops the differential approaches for dealing with the debt overhang based on differential causes of debt overhang.The Regime-Switching model is introduced into the structural credit risk pricing model for discribing how the shocks of economic state on EBIT shift.The Regime-Switching model is embedded into structure credit risk pricing model,and then the debt renegotiation and the bankruptcy clearing thresholds are given.Based on the premise that debt overhang is mainly caused by the shocks of the economic states and the corporation operation ability.This research provides differe ntial approaches for dealing with debt overhang based on the economic cycle theory and the debt renegotiation theory.Specifically.the debt renegotiation and the bankruptcy clearing are used for dealing with debt oxverhang caused by differential factors.The Regime-Switching model and the Geometric Brownian Motion are used to describe the dynamic shocks of the economic cycle factor and the corporation operation factor.At last,the structural credit risk pricing approach is used for pricing.The analytical solutions of the stakeholders' claim values before and after the debt overhang is dealt with.and during the different economic cycles are gixven.The risk implications of the parameters are explored based on the numerical simulation.The results sho\\that:this research achievement is useful in recognizing the causes of the corporation debt overhang and selectin(g the ex-post approaches for dealing with debt overhangj.(3)This research achievement provides an ex-ante approach for dealing with debt o.verhang based on CoCos.The debt-to-equity trigger design method of CoCos based on the capital structure characteristic when the corporation falls into the financial distress caused by debt overhang.The CoCos compatibility for dealing with debt overhang is promoted.CoCos can automatically convert to stocks under the agreed conditions.It allows that the corporations who have issued CoCos can adjust the capital structures automatically in the future.Therefore,this research proposes an ex-ante method for dealing with debt overhang.More specifically,the corporation should issue CoCos in an appropriate amount to partially replace the senior debt in debt financing.On one hand,the above method can reduce the loss of the asset value caused by the debt renegotiation cost,on the other hand,the original shareholders consider that the CoCos conversion would lead to equity dilution,and thus they may restrict their operations.This research improves the compatibility of CoCos conversion trigger for dealing with debt overhang in order to develop an effective ex-ante approach for dealing with debt overhang.Further,the structural credit risk pricing approach is used for pricing.The analytical solutions of the CoCos value and the stakeholders' claim values are given,and the risk implications of the parameters are explored based on the numerical simulations.The results show that:this research achievement is useful in promoting the CoCos conversion trigger design and improving the compatibility of CoCos for dealing with debt overhang.(4)This research achievement embeds the Parisian Option style equity withdrawal clause into CoCos.It promotes the ex-ante methods for dealing with debt overhang.It may ruduce the negative effects of the agency conflicts caused by the equity dilution caused by CoCos conversion and reduce the stakeholders' manipulation motivations.The excessive equity dilution caused by CoCos conversion may lead to agency conflicts.Embedding the equity withdrawal clause can incent the original shareholders to work harder.This research uses the continuous timing trigger condition of the up-and-out Parisian barrier option to design the equity withdrawal clause(mandatory equity repurchase clause),and then improves the“vanilla barrier option"style barrier trigger design method.This can ensure that the corporation has stable operation state and has enough equity repurchase ability,make the above terms not easy to manipulate,and reduce the agency conflicts.Further,the structural credit risk pricing approach is used for pricing.The analytical solutions of the CoCos value and the stakeholders' claim values are given,and the risk implications of the parameters are explored based on the numerical simulations.The results show that:when the corporation is operating stabilized,the credit spread of the CoCos with the Parisian option style equity withdrawal clause is lower,which means the lower issuance cost and the higher issuance efficiency.In conclusion,the main works of this paper can be summarized as follows:Firstly,it designs the ex-post and ex-ante approaches for dealing with debt overhang based on the debt renegotiation and CoCos.The debt overhang is delt with effectively and incentive-compatibily by balancing the stakeholders' risk and benefits.Secondly,it designs targeted terms and builds the pricing models based on the structural credit risk approach.The analytical solutions of the stakeholders' claim values in different methods for dealing with debt overhang are given,and then the massive numerical simulations are given for studying the basis of designs and the application conditions of the methods for dealing with debt overhang from different angles.Thirdly,this paper enriches the design approaches of the debt payoff styles and CoCos clauses.It is expected to design an integrated method for dealing with debt overhang,which can combine the ex-ante risk controlling,the in-event risk buffering and the ex-post risk sharing together.And the more effective solutions for controlling and rescuing the extreme financial risk may be provided.