Lecture 4 bargaining strategies

Question 1

in what kind of business processes is bargaining important?

Answer 1

Mergers and Acquistions
financing structures
supplier relations
customer trade deals
financial distress

Question 2

there are two main types of bargaining games, what are they?

Answer 2

strategic games
cooperative games

Question 3

what are examples of strategic games

Answer 3

static games (prisoner’s dillema)
repeated games ( cournot;s game)

Question 4

what are examples of cooperative games

Answer 4

nash bargaining solution
shapley value

cooperative games include credible threat that enforces solution

Question 5

what are features of cooperative bargaining?

Answer 5

• Total payoff created through cooperation is larger than the sum of the payoffs that can be achieved individually without cooperation -> strategic games are frequently inefficient
• Bargaining is about the surplus that is created via bargaining -> no party would accept lower outcome than the obtainable via outside-option
• Option side option/threat exists
• Multiple possible outcomes that depend on bargaining power of participants

Question 6

Liquidation bargaining model

Answer 6

• Firm with one class of creditors and equity holders
• Two possible outcomes
  o Going-concern ->creditors convert money into equity (debt-equity-swap)
  o Liquidate -> creditors receive remaining firm value (equity holders receive nothing)
• Liquidation would cause bankruptcy costs of a (e.g., 10% proportional to remaining firm value) and additional fixed costs of K
• Upon reorganization, stockholders (creditors) receive fraction 𝜃 (1- 𝜃 of remaining firm value V before bankruptcy
• Goal is to determine the optimal split of Vd
• N: bargaining power coefficient of shareholders ( 0< n < 1)

Question 7

Formula for the optimal sharing rule

Answer 7

= min( n, n * (a * vd + k)/ Vd)
this is the proportion the shareholders gets
n = bargaining power of shareholder
vd = value distressed firm
k is fixed liquidaiton costs
a = variable liquidation costs

Question 8

Exercise:
Vd = 80
a = 0.2
K = 10
n = 0.5
What is the optimal share ratio?
howmuch would the shareholders get?
howmuch would the debt holders get?
And for liquidation?

Answer 8

(0.280+10)/800.5 = 0.1625
Shareholders get 0.1625* 80 = 13
creditors get 1 – 0.1625 * 80 = 67
If liquidation shareholders get 0
creditors get (1 – 0.2) * 80 – 10 = 54

Question 9

Who benefit from financial distress costs?

Answer 9

equity holders, since the sharing rule will be higher the upper bound of the formula

Question 10

which rule is violated with the bargaining model?

Answer 10

Absolute priority rule