This paper presents a model of financially distressed firms with outstanding bank and public debt, analyzing how coordination problems among public debtholders lead to investment inefficiencies in the workout process. The authors show that Chapter 11 reorganization law increases investment and characterize the types of corporate financial structures for which this increased investment enhances efficiency. The paper discusses the effects of reorganization law on the operating decisions of firms both in and out of bankruptcy. The model considers a financially distressed firm with both privately-placed debt (bank debt) and publicly-traded debt (public debt). The key difference between the two types of debt is that it is generally easier to restructure bank debt than public debt: bank debt is usually held by one bank or a syndicate of banks, while public debt is often diffusely held. The paper shows that the inability to renegotiate with public debtholders can lead financially distressed companies to underinvest. Because public debtholders claim part of the cash flows from new investment, distressed firms have difficulty issuing equity or debt for new investment. Thus, they may pass up positive net present value investments. The paper also discusses the effects of public debt restructurings, such as exchange offers, which allow firms to renegotiate their debt. However, these offers can be difficult to complete due to free-rider problems, where some debtholders have an incentive to hold out. The paper shows that offering more senior securities, shorter maturity debt, or cash can mitigate this problem. Additionally, the paper discusses the effects of Chapter 11 reorganization law on out-of-court workouts, arguing that three features of the Bankruptcy Code are particularly powerful in affecting investment: the automatic stay, the voting procedure for plan approval, and the maintenance of equity value even though creditors are not paid in full. The automatic stay extends the maturity of a distressed firm's debt and thereby increases investment. The voting rule overcomes the free-rider problem in exchange offers. And, the maintenance of equity value in Chapter 11 can provide strong incentives for creditors to invest in an out-of-court workout and it can reduce inefficient risk-taking outside of bankruptcy. The paper concludes that the ability to exchange for more senior securities or have excess cash to exchange for cash can be profitable for the firm. However, the ability to exchange does nothing to improve the efficiency of investment decisions of financially distressed firms if there is no seniority covenant in the public debt; it just affects who bears the costs of financial distress. The paper also shows that the possibility of exchanges may affect investment behavior if there is a seniority covenant in the public debt because exchanges can be used to strip the debt of its covenant.This paper presents a model of financially distressed firms with outstanding bank and public debt, analyzing how coordination problems among public debtholders lead to investment inefficiencies in the workout process. The authors show that Chapter 11 reorganization law increases investment and characterize the types of corporate financial structures for which this increased investment enhances efficiency. The paper discusses the effects of reorganization law on the operating decisions of firms both in and out of bankruptcy. The model considers a financially distressed firm with both privately-placed debt (bank debt) and publicly-traded debt (public debt). The key difference between the two types of debt is that it is generally easier to restructure bank debt than public debt: bank debt is usually held by one bank or a syndicate of banks, while public debt is often diffusely held. The paper shows that the inability to renegotiate with public debtholders can lead financially distressed companies to underinvest. Because public debtholders claim part of the cash flows from new investment, distressed firms have difficulty issuing equity or debt for new investment. Thus, they may pass up positive net present value investments. The paper also discusses the effects of public debt restructurings, such as exchange offers, which allow firms to renegotiate their debt. However, these offers can be difficult to complete due to free-rider problems, where some debtholders have an incentive to hold out. The paper shows that offering more senior securities, shorter maturity debt, or cash can mitigate this problem. Additionally, the paper discusses the effects of Chapter 11 reorganization law on out-of-court workouts, arguing that three features of the Bankruptcy Code are particularly powerful in affecting investment: the automatic stay, the voting procedure for plan approval, and the maintenance of equity value even though creditors are not paid in full. The automatic stay extends the maturity of a distressed firm's debt and thereby increases investment. The voting rule overcomes the free-rider problem in exchange offers. And, the maintenance of equity value in Chapter 11 can provide strong incentives for creditors to invest in an out-of-court workout and it can reduce inefficient risk-taking outside of bankruptcy. The paper concludes that the ability to exchange for more senior securities or have excess cash to exchange for cash can be profitable for the firm. However, the ability to exchange does nothing to improve the efficiency of investment decisions of financially distressed firms if there is no seniority covenant in the public debt; it just affects who bears the costs of financial distress. The paper also shows that the possibility of exchanges may affect investment behavior if there is a seniority covenant in the public debt because exchanges can be used to strip the debt of its covenant.