Question

Describe a debt overhang problem and discuss why the problem can be alleviated if senior debtholders and equityholders renegotiate the term of bond contracts (e.g., seniority of the debt-in-place).

Answer 1

Debt overhang problem would be, when senior debt holders are trying to interfere in to the management of the company and trying to hamper the decision making process of the company because they feel like these decisions can impact their solvency risk, and recovery proceedings from the company and they will have to take risk against their collateral.

These problems can be eliminated by negotiations between senior debt holders and equity holders because these are the two parties who are involved into the conflict and they can renegotiate their terms and condition and find a midway through which the interest of both the parties are protected in the long run and it will help to maximize the the overall wealth of the company.

There should always be a focus on redressal of conflict of interest in order to have proper structure in place which will allow both the debt holders and equity holders to always renegotiate because it is a a sign of flexibility in the company which will help in the generation of long-term wealth for both the parties involved.