In this paper, we analyse the restructuring of debt in the presence of debt overhang. The firm starts out with a debt liability and an investment opportunity. Then with unrestructured debt, the firm maintains the current borrowing payments until default or investment. If the creditors allow the parties to restructure the debt with exchange offers, then the borrowing payments change as well as the default and investment points. We find that there is a unique optimal restructuring path which maintains debt at positive levels but defers default indefinitely. This path is optimal regardless of whether the debt holders or the firm control the process through superior bargaining power. Moreover, a debt-for-equity exchange to remove all existing debt takes place just before investment that is followed by the issue of an optimal amount of new debt as part of the funding for the investment cost. The optimal investment trigger is higher along the optimal restructuring path than it is for an unlevered firm. We discuss the findings in the light of existing empirical evidence.

Given the importance of capital regulation in the banking industry, how and why a bank's behavior reacts to a recapitalization has profound consequences. To this end, we investigate the effects of 306 seasoned equity offerings (SEOs) conducted by listed European banks between 2002 and 2014. We use propensity score matching and find that SEOs lead to asset expansion as opposed to any deleveraging. Further, we find a decrease in lending in the short-term followed by a subsequent increase, a reduction in profitability, and an increase in systemic risk. Regulators might not have fully considered this last negative externality when they imposed the tougher Basel III capital requirements. The effects of SEOs strongly depend on the reasons behind the recapitalizations.