CHAPTER 9. BANKRUPTCY PROCEDURES 9.3.4 Competitive equilibrium, once again Call f a competitive allocation if (, p, V) is a competitive equilibrium for some prices (p, V) Theorem 4 If f is a competitive allocation, then there exists a Nash librium(w, i)of the revelation game such that f is ler-efficient for the omy represented by the strategy profile(a, i. Conversely, if(a, 0) is a Nash quilibrium of the revelation game and f is the lea-efficient allocation corre- sponding to(w, 0), then f is a competitive allocation 9.3.5 Discussion there are three classes of claimants, senior debtholders(i= 1) junior debtholders(i=2), and shareholders(i= 3). Let Di denote the face value of the debt for i =1.2. There is assumed to be a unit measure of identical individuals in each class. Assume that and 1>>t2>t3=0, where w is the cash holding of a typical member of class i and valuation of the re-organized firm of a typical member of class i.(We assume that only a single plan to re-organize the firm is on the table Consider first the case in which only cash bids are allowed. Since only class 2 has cash, the maximum cash bid will be w2 which is less than class 2s valuation. Thus, the market value of the firm is V The value of the debt will be D,= I D2=0. This outcome is inefficient, because class l ends up holding cash, not equity, even though it values the equity more than class 2 Now suppose that a secondary market on which equity can be traded for cash opens after the resolution of the bankruptcy. What will happen? Class8 CHAPTER 9. BANKRUPTCY PROCEDURES 9.3.4 Competitive equilibrium, once again Call f a competitive allocation if (f, p, V ) is a competitive equilibrium for some prices (p, V ). Theorem 4 If f is a competitive allocation, then there exists a Nash equi￾librium ( ˆw, vˆ) of the revelation game such that f is lex-efficient for the econ￾omy represented by the strategy profile ( ˆw, vˆ). Conversely, if ( ˆw, vˆ) is a Nash equilibrium of the revelation game and f is the lex-efficient allocation corre￾sponding to ( ˆw, vˆ), then f is a competitive allocation. 9.3.5 Discussion Suppose there are three classes of claimants, senior debtholders (i = 1), junior debtholders (i = 2), and shareholders (i = 3). Let Di denote the face value of the debt for i = 1, 2. There is assumed to be a unit measure of identical individuals in each class. Assume that w2 > w1 = w3 = 0 and v1 > v2 > w2 > v3 = 0, where wi is the cash holding of a typical member of class i and vi is the valuation of the re-organized firm of a typical member of class i. (We assume that only a single plan to re-organize the firm is on the table). Consider first the case in which only cash bids are allowed. Since only class 2 has cash, the maximum cash bid will be w2 which is less than class 2’s valuation. Thus, the market value of the firm is V = w2 < v2. The value of the debt will be p1D1 = V = w2, p2D2 = 0. This outcome is inefficient, because class 1 ends up holding cash, not equity, even though it values the equity more than class 2. Now suppose that a secondary market on which equity can be traded for cash opens after the resolution of the bankruptcy. What will happen? Class