Ex Ante Costs of Violating Absolute Priority in Bankruptcy
Lucian A. Bebchuk
Harvard Law School; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR) and European Corporate Governance Institute (ECGI)
Journal of Finance, Vol. 57, pp. 445-460, 2002
Harvard Law and Economics Discussion Paper No. 328, 2001
A basic question for the design of bankruptcy law concerns whether value should be divided in accordance with absolute priority. Research done in the past decade has suggested that deviations from absolute priority have beneficial ex ante effects. In contrast, this paper shows that ex post deviations from absolute priority also have negative effects on ex ante decisions taken by shareholders. Such deviations aggravate the moral hazard problem with respect to project choice - increasing the equityholders' incentive to favor risky projects - as well as with respect to borrowing and dividend decisions.
Number of Pages in PDF File: 25
Keywords: Bankruptcy, Chapter 11, corporate reorganizations, workouts, absolute priority, moral hazard, asset dilution, claim dilution
JEL Classification: G33, K20, K22Accepted Paper Series
Date posted: July 21, 2001 ; Last revised: May 10, 2009
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