Co-ordination failure and the role of banks in the resolution of financial distress

This article discusses the out-of-court restructuring of the contractual obligations of a financially distressed firm, under conditions of asymmetric information among the firm’s creditors and in situations where a creditor bank makes concessions conditional on other creditors’ actions. I show that a bank’s conditional commitment to support the financially distressed firm may inject a degree of strategic solidity among other creditors and reduce the deadweight costs of inefficient liquidation. However, should a bank’s concession be made conditional on a high tendering rate by other creditors, this may negate the positive information externality of bank’s action. Low minimum tendering rates, on the other hand, may lead to multiple equilibria in creditors’ strategies; but, all those equilibria are shown to be Pareto improving of the unique equilibrium when there is no bank in the game.