Ex Ante Costs of Violating Absolute Priority in Bankruptcy
Lucian A. Bebchuk
Harvard Law School; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)
CEPR Discussion Paper No. 2914
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: 26
Keywords: Bankruptcy, Chapter 11, corporate reorganizations, workouts, absolute priority, moral hazard, asset dilution, claim dilution
JEL Classification: G33, K20, K22working papers series
Date posted: September 27, 2001
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