Repeated dilution of diffusely held debt

Debt with many creditors is analyzed in a continuous-time pricing model of the levered firm in the presence of corporate taxes. We specifically allow for debtor opportunism in form of repeated strategic renegotiation offers and default threats. Dispersed creditors will only accept coupon concessions in exchange for guaranteed liquidation rights, e.g. collateral. The ex ante optimal debt contract is secured with assets which gradually become worthless as the firm approaches the preferred liquidation conditions, in order to allow for sufficient, but delayed renegotiability. Compared with single creditor debt, dispersed debt offers a larger debt capacity, and it is preferable ex-ante if the value of collateralizable assets is then reduced. Our model can explain credit risk premia in excess of those supported by a single creditor model with opportunistic renegotiation.