3421 results in Law and Economics
Part IV - Workouts or bargaining in the shadow of bankruptcy
- Edited by Jagdeep S. Bhandari, Duquesne University, Pittsburgh, Lawrence A. Weiss
- Foreword by Richard A. Posner, INSEAD, Fontainebleau, France
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- Corporate Bankruptcy
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- 10 December 2009
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- 29 March 1996, pp 307-307
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Summary
Although bankruptcy law is apparently designed to address the problems of creditors too dispersed to negotiate effectively for disposition of an insolvent firm's assets, settlement impediments can exist even if all important creditors can get together and negotiate face to face. Even with a limited number of creditors, one or more creditors may behave strategically, threatening to exercise destructive individual collection rights unless other creditors make concessions. The two chapters in the part, Stuart Gilson, “Managing Defaults: Some Evidence on How Firms Choose Between Workouts and Bankruptcy,” and John McConnell and Henri Servaes, “The Economics of Prepackaged Bankruptcy,” explain how creditors can use the bankruptcy process to impose a negotiated settlement on potential holdouts. Such use of the bankruptcy process would be expedited as compared to the imbroglios described by previous selection in the book.
Moreover, as Gilson and McConnell and Servaes illustrate, workouts, whether or not enforced by a “prepackaged” bankruptcy case, will reflect bankruptcy law entitlements, but need not lead to all the inefficiencies described by prior chapters.
Preface
- Edited by Jagdeep S. Bhandari, Duquesne University, Pittsburgh, Lawrence A. Weiss
- Foreword by Richard A. Posner, INSEAD, Fontainebleau, France
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- Book:
- Corporate Bankruptcy
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- 10 December 2009
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- 29 March 1996, pp xv-xviii
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Summary
This book has been a long time in process. It was apparent to most observers some years ago that economic analysis of law had matured. Law and economics scholars produced a multitude of papers that found their way into existing and newly begun journals. Readers or edited volumes appeared in various areas of the law such as torts, contracts, antitrust administrative law, and corporate law. For various reasons, economic analysis of bankruptcy law was somewhat slower in developing. This may appear puzzling, at first, in view of the fact that many issues in bankruptcy intimately implicate financial or economic considerations. Perhaps, the slower application of economic methods or analyses to bankruptcy law partly can be ascribed to the fact that most scholars of bankruptcy law in the late 1970s and early 1980s were not yet tutored in economic thinking. And, in any case,the bankruptcy law underwent a major revision in 1978. Consequently, some time elapsed before experience accumulated with the new law and before scholars of bankruptcy law mastered the tools of both theoretical and quantitative economics.
The last decade has witnessed a very rapid growth in scholarship employing economic reasoning and methods to various issues in bankruptcy law and a large body of such literature now exists in the form of articles and even case-books. However, to our knowledge, there is, as of yet, no existing reader or convenient collection of articles in this area, analogous to the many edited volumes in other areas of the law.
13 - Bankruptcy and risk allocation
- Edited by Jagdeep S. Bhandari, Duquesne University, Pittsburgh, Lawrence A. Weiss
- Foreword by Richard A. Posner, INSEAD, Fontainebleau, France
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- Corporate Bankruptcy
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- 10 December 2009
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- 29 March 1996, pp 190-206
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Summary
Introduction
Bankrupt business firms distribute property to low-priority investors even though the firms do not fully repay high-priority investors. That bankruptcy in this way alters contractual priorities effectively reallocates among investors the risk of business insolvency. Commentators have roundly criticized such reallocation as an impediment to efficient business practice. Recently, however, a “risk-sharing” defense of bankruptcy reallocation has appeared in both the law and finance literature. Risk-sharing theorists argue that all investors in a business debtor – equity investors and creditors alike – would choose to share the risk of loss from the debtor's insolvency. These theorists surmise that investors cannot agree to share such risk, because a risk-sharing agreement is prohibitively expensive to negotiate. Therefore, the theorists conclude, bankruptcy reallocation furnishes a mutually beneficial hypothetical bargain to which investors would expressly agree but for transaction difficulties.
Though ostensibly plausible, risk-sharing theory must overcome a formidable obstacle: the actual bargain among investors is not silent on how to allocate insolvency risk. That bargain, in the form of equity and creditor contracts, expressly allocates insolvency risk to the low-priority, or “junior,” investors (i.e., to equity investors and general unsecured creditors). Thus bankruptcy reallocation appears to conflict with the parties' express intent.
Moreover, one cannot properly attribute contractual priority to transaction costs. Contractual priority reflects a bargain struck within the network of contracts that comprises every firm. As part of the investors' contractual network, equity investors purchase residual claims subordinate to those of creditors.
25 - Debtor's choice: A menu approach to corporate bankruptcy
- Edited by Jagdeep S. Bhandari, Duquesne University, Pittsburgh, Lawrence A. Weiss
- Foreword by Richard A. Posner, INSEAD, Fontainebleau, France
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- Corporate Bankruptcy
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- 10 December 2009
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- 29 March 1996, pp 395-407
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Summary
Any attempt to justify bankruptcy law from a normative perspective should begin with the observation that bankruptcy law is a term of the contract between the firm and those who extend credit to it. To see why this is so, consider the position of a lender deciding whether to extend credit to the firm and, if so, at what price. The lender will compare the return that it can expect to receive from the firm to the return that it could expect to receive from its best alternate investment. This sets the minimum price that the lender will agree to in order to accept the contract.
The maximum price to which the debtor will agree is set by the debtor's source of alternative funding. The rate of interest which the lender will charge will depend in large part on its assessment of the probability that the firm will be able to repay the loan. The lender will consider the sum of the payments which it expects the firm to make, and discount these payments to present value. If the lender faces no chance of default by the borrower, the interest rate that the lender charges will be relatively low. As the risk of not being paid in full rises, so does the interest rate. Thus we are not surprised when we see healthy companies getting loans at lower rates than more risky companies receive.
22 - The uneasy case for corporate reorganizations
- Edited by Jagdeep S. Bhandari, Duquesne University, Pittsburgh, Lawrence A. Weiss
- Foreword by Richard A. Posner, INSEAD, Fontainebleau, France
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- Book:
- Corporate Bankruptcy
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- 10 December 2009
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- 29 March 1996, pp 336-350
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Summary
A bankruptcy proceeding is a day of reckoning for all parties with ownership interests in an insolvent firm. Ownership interests are valued, the assets are sold, and the proceeds are divided among the owners. Bankruptcy proceedings take one of two forms, depending on whether ownership rights to the assets are sold on the open market to one or more third parties or whether ownership rights to the assets are transferred to the old owners in return for the cancellation of their prebankruptcy entitlements. The first kind of bankruptcy proceeding, a liquidation, is governed by chapter 7 of the Bankruptcy Code; the second kind, a reorganization, is governed by chapter 11. A bankruptcy proceeding always involves a sale of assets followed by a division of the proceeds among the existing owners. In a chapter 7 proceeding the sale is real; in a chapter 11 proceeding the sale is hypothetical.
An analysis of the law of corporate reorganizations should properly begin with a discussion of whether all those with rights to the assets of a firm (be they bondholders, stockholders, or workers) would bargain for one if they had the opportunity to negotiate at the time of their initial investment. Properly understood, a bankruptcy proceeding itself can be seen as the back end of the “creditors' bargain.” If they had the opportunity, investors in a firm might bargain to accept a bankruptcy proceeding in advance in order to avoid a destructive race to a firm's assets that could arise when several investors exercise their right to withdraw their contribution to the firm.
32 - The role of banks in reducing the costs of financial distress in Japan
- Edited by Jagdeep S. Bhandari, Duquesne University, Pittsburgh, Lawrence A. Weiss
- Foreword by Richard A. Posner, INSEAD, Fontainebleau, France
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- Book:
- Corporate Bankruptcy
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- 10 December 2009
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- 29 March 1996, pp 531-549
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Summary
Introduction
The increase in leverage of many U.S. corporations in the 1980s has touched off a public debate about its effect on economic activity. In one view, large debt burdens constrain investment and threaten financial stability; in another, they prevent corporate waste and improve economic performance. Either way, high leverage increases the likelihood that firms will be unable to make their debt payments, and it raises concern about what happens to these distressed firms. Some argue that, as long as a firm has good prospects, financial distress will have no real impact; the firm's debt will be renegotiated to ensure its survival. Others take a less sanguine view: Creditors' conflicting claims make renegotiation difficult and may lead creditors to liquidate the firm even though it is collectively inefficient for them to do so.
Both theories of financial distress have some appeal, but there are virtually no facts to lead us to one or the other. In this chapter we attempt to bring some evidence to bear on this question. We analyze how financial distress affects firm's investment behavior and their performance in product markets. Our empirical evidence suggests that financial distress is costly for firms that are likely to have significant conflicts among their creditors.
The evidence is from Japan. We focus on Japanese firms because of the kind of financial environment in which they operate. Many firms in Japan have very close ties to a main bank.
Part I - The role of credit
- Edited by Jagdeep S. Bhandari, Duquesne University, Pittsburgh, Lawrence A. Weiss
- Foreword by Richard A. Posner, INSEAD, Fontainebleau, France
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- Book:
- Corporate Bankruptcy
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- 10 December 2009
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- 29 March 1996, pp 1-2
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Summary
A corporation finances its operations (working capital and long-term assets) by issuing a combination of equity and credit. A firm may compensate suppliers of equity capital with dividends and, eventually, with proceeds from the firm's liquidation. The right to either, however, is residual and subject to any creditor claims. The only noncontingent right of an equity investor is the right to vote on matters of concern to the firm; most importantly, the right to elect the firm's managers. In contrast to its relationship with equity investors, a firm agrees to compensate creditors with fixed payments. A creditor's right to payment generally is noncontingent and, in the event a firm defaults on a fixed obligation, the unpaid creditor may begin collection proceedings pursuant to applicable nonbankruptcy law.
In a world without bankruptcy law, a collecting creditor might seize assets critical to the corporation's operation. A bankruptcy petition temporarily halts all legal proceedings against the debtor corporation and provides a period of time, or breathing space, for the corporation to renegotiate its fixed obligations. The nature and propriety of this breathing space is the subject of much of the literature on bankruptcy. However, the logical starting point for a book on corporate bankruptcy is an explanation of debt itself, because without debt's fixed obligations there would be no threat of destructive collection and no firm would need bankruptcy protection.
The first chapter in the book is the Nobel Memorial Prize Lecture “Leverage” by Merton Miller. In this lecture Miller uses recent concern about leveraged buyouts in the United States to explain the inherent advantages of fixed obligations to a firm – advantages that go beyond any benefits that result from United States income tax laws.
Index
- Edited by Jagdeep S. Bhandari, Duquesne University, Pittsburgh, Lawrence A. Weiss
- Foreword by Richard A. Posner, INSEAD, Fontainebleau, France
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- Book:
- Corporate Bankruptcy
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- 10 December 2009
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- 29 March 1996, pp 550-559
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15 - Bargaining over equity's share in the bankruptcy reorganization of large, publicly held companies
- Edited by Jagdeep S. Bhandari, Duquesne University, Pittsburgh, Lawrence A. Weiss
- Foreword by Richard A. Posner, INSEAD, Fontainebleau, France
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- Book:
- Corporate Bankruptcy
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- 10 December 2009
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- 29 March 1996, pp 232-259
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Summary
This chapter reports some of the results of an empirical study of the bankruptcy reorganization of large, publicly held companies. We present data relevant to what many consider to be the central issue of reorganization theory – how the value of the reorganizing enterprise should be divided among the various claims and interests. We demonstrate that there is indeed systematic deviation from the absolute priority rule in favor of junior interests; but, with respect to large, publicly held corporations, the debate about how to prevent these deviations is, for the most part, a tempest in a teapot – the difference between absolute priority and the actual outcomes of these cases is relatively small.
[Part I, on the legal context in which bargaining occurs, and Part II, on the history and theory of bargaining in bankruptcy cases, have been removed as they address issues discussed in other articles included in this volume.] Part III describe[s] our methodology. In Part IV we present our findings as to the frequency of “settlement” in these cases. In Parts V and VI, we present our findings as to the terms of settlement, comparing the legal entitlements of various participants in hypothetical adjudications and their recoveries under the actual settlement agreements. In these parts, we also discuss the possible reasons for “gaps” between the hypothetically correct solutions in adjudication (as provided by the absolute priority rule) and the settled outcomes. Part VII discusses the implications of these empirical findings for bankruptcy policy.
28 - Financial and political theories of American corporate bankruptcy
- Edited by Jagdeep S. Bhandari, Duquesne University, Pittsburgh, Lawrence A. Weiss
- Foreword by Richard A. Posner, INSEAD, Fontainebleau, France
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- Book:
- Corporate Bankruptcy
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- 10 December 2009
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- 29 March 1996, pp 434-448
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Summary
Introduction
What explains American corporate bankruptcy, with its time-consuming and expensive reorganization process? Accepted wisdom is that bankruptcy protects an insolvent debtor's assets from its creditors who would otherwise dismantle the debtor in a frenzied attempt to collect on their loans. By providing for an orderly disposition of claims against a debtor firm, bankruptcy law preserves intact the firm's “common pool” of assets available to creditors. In this classic account, creditors willingly bear the costs of bankruptcy because the alternative is worse: a contentious race among creditors and destruction of the firm. Thus, the bankruptcy system is seen as a lesser of evils.
I argue here that the willingness of creditors and other investors to accept the corporate bankruptcy process is as much a political adaptation as an economic decision. The common pool justification for corporate bankruptcy is unsatisfactory. It assumes that without bankruptcy law creditors would destroy insolvent, but viable firms. This assumption is ill-founded. In a legal environment hospitable to all forms of contract, investors could agree efficiently to preserve a firm's value without the aid of the costly, rule-based bankruptcy process. We do not observe such agreements in the United States because political compromises have produced a legal regime that discourages optimal contracts.
The Common Pool Illusion
A solution to the supposed common pool problem lies at the heart of existing bankruptcy law. Bankruptcy's proponents argue that creditors of an insolvent firm, left to their own devices, would expend resources first preparing for, then entering, a race to collect limited assets.
3 - A theory of loan priorities
- Edited by Jagdeep S. Bhandari, Duquesne University, Pittsburgh, Lawrence A. Weiss
- Foreword by Richard A. Posner, INSEAD, Fontainebleau, France
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- Corporate Bankruptcy
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- 10 December 2009
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- 29 March 1996, pp 17-24
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Summary
This article analyzes priorities among lenders in an insolvent debtor's personal property. Current law regulating these priorities rests on three priority principles: First, if the first creditor to deal with the debtor makes an unsecured loan, it shares pro rata with later unsecured creditors in the debtor's assets on default. Second, if this initial creditor makes an unsecured loan and a later creditor takes security, the later creditor has priority over the initial creditor in the assets subject to the security interest. Third, if the initial creditor makes a secured loan, it generally has priority over later creditors in the assets in which it has security.
There are several exceptions to this third principle of “first in time is first in right,” of which probably the most important is the purchase-money priority: A later creditor whose funds enable the debtor to purchase designated assets and who takes a security interest in these assets will have priority in them despite an earlier security interest that would otherwise have granted senior rank to the initial secured lender.
The legal rules that these three priority principles imply also hold independently of the contract between the initial financer and debtor. For example, if this creditor makes an unsecured loan but obtains from the debtor a covenant not to make future secured loans – a negative pledge clause – the covenant will not affect the debtor's power to grant security and, thus, senior rank to a subsequent lender.
24 - A new approach to corporate reorganizations
- Edited by Jagdeep S. Bhandari, Duquesne University, Pittsburgh, Lawrence A. Weiss
- Foreword by Richard A. Posner, INSEAD, Fontainebleau, France
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- Book:
- Corporate Bankruptcy
- Published online:
- 10 December 2009
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- 29 March 1996, pp 370-394
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Summary
Introduction
The concern of this chapter is the way in which corporate reorganizations divide the reorganization pie. The chapter puts forward a new method for making the necessary division. This method can address some major efficiency and fairness problems long thought to be inherent in corporate reorganizations. Although the method is proposed as a basis for law reform, it can also be used under the existing rules.
Reorganization is one of the two routes that a corporation bankruptcy may take. When a corporation becomes insolvent and bankruptcy proceedings are commenced, the corporation is either liquidated or reorganized. In liquidation, which is governed by chapter 7 of the Bankruptcy Code, the assets of the corporation are sold, either piecemeal or as a going concern. The proceeds from this sale are then divided among those who have rights against the corporation, with the division made according to the ranking of these rights.
Reorganization which is governed by chapter 11 of the Bankruptcy Code, is an alternative to liquidation. Reorganization is essentially a sale of a company to the existing “participants” – all those who hold claims against or interests in the company. This “sale” is of course a hypothetical one. The participants pay for the company with their existing claims and interests; in exchange, they receive K “tickets” in the reorganized company – that is, claims against or interests in this new entity.
Part V - Alternatives to bankruptcy and the creditors' bargain
- Edited by Jagdeep S. Bhandari, Duquesne University, Pittsburgh, Lawrence A. Weiss
- Foreword by Richard A. Posner, INSEAD, Fontainebleau, France
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- Book:
- Corporate Bankruptcy
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- 10 December 2009
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- 29 March 1996, pp 327-328
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Summary
Despite the arguable benefits from breaches in absolute priority described by the chapters in Part III and the possibility of private workouts or expedited bankruptcy proceedings described by the chapters in Part IV, the bankruptcy reorganization process is costly for many firms. A number of chapters in Part II provide details about those costs. This part explores the possibility that alternatives to bankruptcy can provide investors with the benefits from the bankruptcy process without the costs that this process imposes on at least some firms.
The first five chapters in this part explore the idea that market valuations can simplify the insolvency process. If the market established a value for an insolvent firm's assets, many of the disputed issues in a bankruptcy reorganization would disappear. In the simplest case, a bankruptcy court could auction an insolvent firm for cash, then distribute the cash to claimants in accordance with the claimants' contractual priorities. The purchaser and not the court would have the problem of restructuring the firm's finances. And the court would not have to decide the value of the property it distributed; there can be no debate over the value of cash. With this theme of simplification in mind Michael Jensen, “Corporate Control and the Politics of Finance,” Douglas G. Baird, “The Uneasy Case for Corporate Reorganizations,” Mark J. Roe, “Bankruptcy and Debt: A New Model for Corporate Reorganization,” and Lucian A. Bebchuk “A New Approach to Corporate Reorganizations” offer various schemes to value an insolvent firm through the sale or distribution of unvalued interests in a bankrupt firm.
26 - Is corporate bankruptcy efficient?
- Edited by Jagdeep S. Bhandari, Duquesne University, Pittsburgh, Lawrence A. Weiss
- Foreword by Richard A. Posner, INSEAD, Fontainebleau, France
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- Book:
- Corporate Bankruptcy
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- 10 December 2009
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- 29 March 1996, pp 408-414
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Summary
Corporate bankruptcy has two functions:
to deliver the penalty for failure by forcing a wrapping up when a business cannot pay its debts; and
to reduce the social costs of failure.
When a business fails, the legal process writes off claims that have become uncollectible, turns out managers and others responsible for the debacle, and pays the claims for which assets remain. Bankruptcy or a private substitute such as a workout succeeds when this happens quickly (before good money is thrown after bad) and with low transactions costs. Because the process of paying some claims and extinguishing others can lead to a race to carve up the carcass, which may still have a positive cash flow, bankruptcy combines a stay of self-help with a collective forum for the resolution of competing claims. Like the separation theorem of finance, the bankruptcy process divorces decisions about the optimal deployment of assets from decisions about the claims to those assets. If it works well, assets continue to be devoted to their most productive uses.
Bankruptcy certainly writes down claims, and Gilson (1990) finds that it leads to sanctions in the managerial labor market as well. Is the cost worth incurring? Every study of bankruptcy shows it to be expensive, as it is bound to be given creditors' incentives to stake out competing claims to whatever wealth remains. Weiss (1990) measures costs approximating 3 percent of the assets in the bankruptcies of substantial firms. Other estimates run between 3.4 percent and 21 percent for smaller firms.
Part II - Bankruptcy as a reflection of the creditors' implicit bargain
- Edited by Jagdeep S. Bhandari, Duquesne University, Pittsburgh, Lawrence A. Weiss
- Foreword by Richard A. Posner, INSEAD, Fontainebleau, France
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- Book:
- Corporate Bankruptcy
- Published online:
- 10 December 2009
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- 29 March 1996, pp 25-28
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Summary
The chapters included in Part I explain why some firms include debt in their capital structures and others prefer to have debt with heterogeneous levels of priority. The chapters in this part explain the problems debt financing creates and the role of bankruptcy law in addressing those problems.
To understand the problems created by debt financing, imagine a firm that manufactures copper wire at a time when technology dictates that fiber optics will replace most uses of copper wire. The advent of fiber optics makes obsolete much of the manufacturers equipment and requires that the manufacturer substantially retool if it is to stay in business.
This obsolescence and the prospect of retooling significantly reduces the value of the firm compared to its value prior to the introduction of new technology. Such a reduction in value would not precipitate a financial crisis if the firm were financed purely by equity. The equity owners directly or through the firm managers acting as equity agents would simply assess the viability of the firm in the new world of fiber optics. The shareholders or their agents would then decide whether to continue the firm or to wind it up. If the firm continued, it would use existing capital or raise new capital to retool. If the firm wound up, it would liquidate and divide its assets ratably among the shareholders. In either case, the process could be orderly.
Frontmatter
- Edited by Jagdeep S. Bhandari, Duquesne University, Pittsburgh, Lawrence A. Weiss
- Foreword by Richard A. Posner, INSEAD, Fontainebleau, France
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- Book:
- Corporate Bankruptcy
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- 10 December 2009
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- 29 March 1996, pp i-iv
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23 - Bankruptcy and debt: A new model for corporate reorganization
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- By Mark J. Roe
- Edited by Jagdeep S. Bhandari, Duquesne University, Pittsburgh, Lawrence A. Weiss
- Foreword by Richard A. Posner, INSEAD, Fontainebleau, France
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- Book:
- Corporate Bankruptcy
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- 10 December 2009
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- 29 March 1996, pp 351-369
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Summary
General Themes
The core determinations made in a reorganization under chapter 11 of the Bankruptcy Code are simply stated: Who gets how much? What will the reorganized capital structure be? To resolve these simply stated questions, bankruptcy courts now loosely oversee a lengthy bargaining process that is widely thought to be cumbersome, costly, and complex. The strain of extended financial stress – particularly in a bankruptcy proceeding – results in lost sales when customers seek a more secure supply source, in consumption of valuable management time spent resolving financial difficulties, and in foregone opportunities to obtain and to implement new projects. Additional costs are borne by the employees, customers, and suppliers of the bankrupt company, as well as the communities in which it operates.
Three principal characteristics seem desirable for a corporate reorganization mechanism: speed, low cost, and a resulting sound capital structure. Other desirable characteristics are accuracy in valuation and compensation, predictability, and fairness. Accuracy and predictability diminish the uncertainty of the results of bankruptcy reorganizations, facilitating investment in risky but worthwhile enterprises before a bankruptcy occurs. Speed and low cost help diminish the deadweight costs of the bankruptcy when it does occur.
Three general mechanisms might be considered to accomplish a corporate reorganization:
a bargain among creditors and stockholders (i.e., a workout that occurs outside the bankruptcy court or after the filing of a bankruptcy petition), but even then with minimal court supervision;
litigation in which the court imposes a solution and capital structure; and
although rarely even noted as a serious possibility, use of the market.
9 - Bargaining after the fall and the contours of the absolute priority rule
- Edited by Jagdeep S. Bhandari, Duquesne University, Pittsburgh, Lawrence A. Weiss
- Foreword by Richard A. Posner, INSEAD, Fontainebleau, France
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- Book:
- Corporate Bankruptcy
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- 10 December 2009
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- 29 March 1996, pp 113-140
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Summary
The absolute priority rule provides that in a reorganization senior owners are paid in full before junior owners are paid anything. When a firm owes more than its assets are worth, the shareholders receive nothing unless the creditors consent. Under the 1978 Bankruptcy Code, consent can be given through a classwide vote of creditors. A single uncompromising creditor's objection is not sufficient to prevent the participation of shareholders. Nevertheless, the absolute priority rule and its rhetoric stand in distinct contrast to the distrust of market mechanisms and ex ante bargains that pervades both the practice of bankruptcy and discussions of bankruptcy policy. Walter Blum's classic essay, “The Law and Language of Corporate Reorganizations,” takes as its theme this tension between the need for respecting the prebankruptcy bargain and the harshness of vindicating that bargain after the fact. Recognition of that tension permeates much of what he has written since. The insights contained in his work establish the common ground upon which all modern bankruptcy scholars stand.
The dispute in Case v. Los Angeles Lumber Products and the other opinions that gave rise to much of Walter Blum's work, however, developed only after the absolute priority rule was well into middle age. These cases all involved battles between a creditor or group of creditors on the one hand and shareholders on the other. In its infancy, the absolute priority rule involved not two parties but three. In this chapter, we make an effort to extend Walter Blum's work.
5 - Bankruptcy, nonbankruptcy entitlements, and the creditors' bargain
- Edited by Jagdeep S. Bhandari, Duquesne University, Pittsburgh, Lawrence A. Weiss
- Foreword by Richard A. Posner, INSEAD, Fontainebleau, France
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- Corporate Bankruptcy
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- 10 December 2009
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- 29 March 1996, pp 39-57
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Summary
Bankruptcy, at first glance, may be thought of as a procedure geared principally toward relieving an overburdened debtor from “oppressive” debt. Yet this discharge-centered view of bankruptcy is correct neither from an historical perspective nor from a realistic appraisal of the presence and operation of most of the provisions in the federal bankruptcy laws over the years. For although discharge of the debtor (and such related issues as “exemptions” that enable an individual debtor to keep assets out of the bankruptcy pool) may well be the motivating cause of a majority of bankruptcy cases, most of the bankruptcy process is in fact concerned with creditor–distribution questions. Assets are marshalled so that they can be allocated among those holding claims against the debtor or the debtor's property. Claims are determined so that participants in the allocation process may be assembled. And the rules governing priorities determine who, among the claimants, will get what and in what order.
Although the Bankruptcy Code specifies some of these priority rules claimants who fare best in the bankruptcy process hold special entitlements under applicable nonbankruptcy law. The priorities enunciated in the Bankruptcy Code itself deal largely with the allocation of rights among persons not entitled to preferential treatment outside of bankruptcy.
Despite the importance and durability of such distributional rules, no normative theory has been developed against which these intercreditor bankruptcy rules could be examined. This chapter will attempt to supply that theoretical analysis by exploring the role bankruptcy should play in shaping rules for distributions among creditors, and then testing certain existing rules against the resulting model.
Part III - Beyond the basic creditors' bargain
- Edited by Jagdeep S. Bhandari, Duquesne University, Pittsburgh, Lawrence A. Weiss
- Foreword by Richard A. Posner, INSEAD, Fontainebleau, France
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- Book:
- Corporate Bankruptcy
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- 10 December 2009
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- 29 March 1996, pp 109-112
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Summary
Nothing in the basic creditors' bargain heuristic requires that bankruptcy law alter the contractual priorities among claimants to a firm's assets. Indeed several of the chapters included in Part II explore how bankruptcy law can provide a collective proceeding while honoring contractual priorities. Yet bankruptcy's collective process routinely breaches contractual – or “absolute” priority – in that bankrupt firms distribute assets to equity interests though the firms are insolvent and distribute assets to general, low-priority creditors without fully satisfying high-priority claims. These breaches in absolute priority are partly a direct consequence of rules that favor redistribution, and largely a consequence of bankruptcy's expensive negotiation procedures, which induce high-priority claimants to make concessions in return for settlement and termination of the costly process. The chapters in this part explore in more detail how the bankruptcy process alters contractual priorities.
The first chapter is Douglas G. Baird and Thomas H. Jackson, “Bargaining after the fall and the contours of the absolute priority rule.” In this chapter, Baird and Jackson explore the bankruptcy negotiation process among highpriority creditors, low-priority creditors, and equity. They note that this negotiation process may produce breaches in absolute priority if one focuses solely on the outcome. But, Baird and Jackson explain, one must be aware of the possibility that the outcome is a product of a hypothetical distribution consistent with absolute priority followed by creditors' concession to equity as consideration for equity's continued participation in the firm.