OPTIMAL DEBT SERVICE:
STRAIGHT VS. CONVERTIBLE DEBT
Christian Koziol
In this paper, we analyze the optimal default strategy of a firm when debt is convertible into equity. For this purpose, we consider a convertible consol bond in a time-independent model in the presence of bankruptcy costs and tax de-ductibility. The optimal default and conversion strategy result from a game be-tween equity and debt holders. A closed-form solution for the optimal default barrier exists if the firm pays no dividends. We show that an optimal default of convertible debt occurs earlier than a default of otherwise identical straight debt. A further comparison of the optimal default strategy with the strategy for straight debt shows that the value of convertible debt is lower when the firm follows the optimal strategy rather than the strategy for straight debt. Furthermore, we find that the important difference between the default barrier for convertible debt and identical but non-convertible debt rises with the conversion ratio, the coupon, a lower tax rate, and a lower payoff rate.
pp.124-151
DISCUSSION OF “OPTIMAL DEBT SERVICE: STRAIGHT
VS. CONVERTIBLE DEBT”
Gunther Friedl
Corporate bond default plays a signi?cant role in today’s business environment. According to Moody´s, a leading provider of credit ratings, corporate bond issuers that it rated as of January 1, 2004, defaulted on a total of US $16 billion in 2004. Credit default not only affects the equity investors of a ?rm, but also the debt holders, who may loose part of their credit. Default can also have dramatic consequences for a ? rm’s future operations. Therefore, the decision of if and when to default is important for both the ?rm and its stakeholders.
There is a substantial body of literature on the determination of optimal default points as a strategic decision by the owners of a ?rm. According to this view, optimal default occurs when the continuation value of the ?rm, less the discounted value of all future taxadjusted coupon payments, falls below zero. However, some studies on optimal default points are limited, since these studies usually assume a simple capital structure with only equity and straight debt.
pp.152-156
MERGERS IN PATENT CONTEST MODELS
WITH SYNERGIES AND SPILLOVERS
Peter-J. Jost/Claus van der Velden
We consider mergers in an innovation contest between n firms in the presence of synergetic effects. We assume that a merger may affect the R&D efficiency of the merging firm due to increasing returns to scale in R&D. We show that mergers are beneficial for the merging firms even if the efficiency gains of the merging firms are not substantial, and that merging reduces R&D costs by only 6%. We also consider the influence of unintended knowledge flows in R&D. In the presence of knowledge spillovers, we show that higher efficiency gains are needed to make the merger profitable.
pp.157-179
COMMENT ON “MERGERS IN PATENT CONTEST
MODELS WITH SYNERGIES AND SPILLOVERS”
Bernd Schauenberg
Peter-J. Jost and Claus van der Velden, the authors, discuss a very interesting problem. They ask whether horizontal mergers may be profitable.
Their starting point is a well-known result from Salant, Switzer, and Reynolds (1983). They show in a conventional Cournot oligopoly framework that a horizontal merger can hardly be profitable for the merging firms. The merging firms, the insiders, realize some cost advantage after the merger and therefore reduce their output. The non-participating firms, the outsiders, realize that aggregate demand does not change due to the merger and expand their output, given the aggregate output of the insiders. Thus, the sum of the profits of the insiders decreases. When the profit reduction due to the output decision of the outsiders is greater than the cost efficiencies that motivated the merger, then the sum of the insiders’ profits may be smaller after the merger.
The authors examine a research-intensive industry. There are n firms engaged in a patent race. Winning the race results in a large first-mover advantage that may endure for some years. The incentives to innovate are without any reasonable doubt very high. But on the other side, the firms may have an incentive to economize on costs. Depending on either the industry effects or the state of scientific progress, R&D expenditures may be very high for a single firm. These expenditures can be the motive for some of the involved firms to consider a merger. Thus, the authors discuss the trade-off between an incentive to innovate and an incentive to economize on costs.
pp.180-183
THE EFFECT OF SUNK COSTS ON THE OUTCOME OF ALTERNATING-OFFERS BARGAINING BETWEEN INEQUITY-AVERSE AGENTS
Christian Ewerhart
When investments are speci?c to a relationship and contracting possibilities are incomplete, the effciency of a joint venture may be severely impaired by ex-post opportunistic and hold-up type behavior. How is the logic of this argument affected by inequity aversion? In this paper I show that incentives to invest are stronger with inequity aversion because a higher investment by an individual agent increases not only the total surplus to be divided, but also, generally, the relative share of the surplus obtained by this agent in the ex-post negotiation. In fact, when production is suffciently pro?table and agents are suffciently patient, then ?rst-best investment levels may be approximated without any contract.
pp.184-203
DISCUSSION OF “THE EFFECT OF SUNK COSTS ON THE OUTCOME OF ALTERNATING-OFFERS BARGAINING BETWEEN INEQUITY-AVERSE AGENTS”
Elisabeth Gugl
In his article, Ewerhart argues that agents with inequity-averse preferences may overcome the hold-up problem. In this discussion, I focus on the under-lying assumptions that he makes and point to some limitations of the model.
Following is a real world example that fits Ewerhart’s description: Our de-partment requires faculty to submit annual activity statements, which are the basis for merit increments in our salary. Of course, publications play a major role, and departmental policy requires that faculty members who coauthored a journal article need to explain what weight their contribution has. It also happens quite regularly that faculty members in our department coauthor a paper, so the stated contributions in the respective activity statements need to add up to one. Anecdotal evidence suggests that while some people just claim equal distribution without much discussion, there are cases in which faculty members have gone back and forth and finally come up with an un-equal weight on their contributions. However, many faculty members agree that we should not have such a rule. They argue that it discourages coau-thorship, because the second-stage negotiations are such a hassle.
pp.204-208
