Admissible Designs of Debt-Equity Swaps for Distressed Firms: Analysis, Limits and Applications

Abstract

This paper reconsiders the design of debt-equity swaps that are common tools to financially restructure distressed firms. While an ad hoc approach consists in characterizing a set of three parameters, we demonstrate that a system of two equations defines admissible designs. Hence, assuming that creditors do not want to bankrupt the firm nor they want to evict completely current equity holders, we solve the debt holders' design problem. We then undertake an in-depth analysis of corresponding solutions and we show that debt-equity swaps can significantly increase the probability of being reimbursed of the remaining due payment in the next future.