3. Mr. Jones owes $500,000 to each of two creditors, Ms. Smith and Mr. Svensson. Mr....

 

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3. Mr. Jones owes $500,000 to each of two creditors, Ms. Smith and Mr. Svensson. Mr. Jones, however, only has $600,000. If he declares bank- ruptcy, he will lose the whole amount (the $600,000). The legal costs of filing for bankruptcy and litigating the liquidation of his assets are $400,000, leaving only $200,000 to be shared by the two creditors; that is, Ms. Smith and Mr. Svensson will only collect $100,000 each in case of bankruptcy. Mr. Jones now draws up the following letter, which he sends to each of the two creditors: "I hereby offer you and my other creditor $110,000 each if you agree to cancel my debt. If either (or both) of you decline this offer, I will declare bankruptcy". (a) Analyze the resulting game between the two creditors, assuming that the creditors make their decisions simultaneously and have to either accept or decline the offer. (b) Describe the likely implications of an increase in the legal costs of bankruptcy for the behavior of the debtor and the payments to the two creditors. 3. Mr. Jones owes $500,000 to each of two creditors, Ms. Smith and Mr. Svensson. Mr. Jones, however, only has $600,000. If he declares bank- ruptcy, he will lose the whole amount (the $600,000). The legal costs of filing for bankruptcy and litigating the liquidation of his assets are $400,000, leaving only $200,000 to be shared by the two creditors; that is, Ms. Smith and Mr. Svensson will only collect $100,000 each in case of bankruptcy. Mr. Jones now draws up the following letter, which he sends to each of the two creditors: "I hereby offer you and my other creditor $110,000 each if you agree to cancel my debt. If either (or both) of you decline this offer, I will declare bankruptcy". (a) Analyze the resulting game between the two creditors, assuming that the creditors make their decisions simultaneously and have to either accept or decline the offer. (b) Describe the likely implications of an increase in the legal costs of bankruptcy for the behavior of the debtor and the payments to the two creditors.

Answer rating: 100% (QA)

a To analyze the resulting game between the two creditors lets consider the possible strategies and payoffs for each player Player 1 Ms Smith Player 2 ... View the full answer