Abstract

http://ssrn.com/abstract=241220
 
 

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A Dilution Mechanism for Valuing Corporations in Bankruptcy


Barry E. Adler


New York University School of Law

Ian Ayres


Yale University - Yale Law School; Yale University - Yale School of Management

September 2000

NYU, Center for Law and Business Research Paper No. 010; and Yale Law & Economics Research Paper No. 243

Abstract:     
This article proposes a new mechanism for valuing firms in bankruptcy. Under the mechanism, a court would dilute the reorganized stock issued to senior claimants by issuing additional shares to junior claimants until there was no excess demand for the stock at a price that would implement absolute priority. This mechanism could also be adapted so that a court would issue additional debt to senior claimants until there was no excess supply of the debt at a price that would implement absolute priority. We show that the mechanism harnesses the private information of the claimants and of third parties to produce distributions consistent with absolute priority. The dilution mechanism can be superior to other information-harnessing devices (such as an option or auction approach) because it (i) is less susceptible to the problem of junior illiquidity than an option approach proposed by Lucian Bebchuk; (ii) is less susceptible to the problem of market manipulation and may better allocate control premia than a partial float proposal by Mark Roe; and (iii) may produce fewer transaction costs than a full auction approach proposed by Douglas Baird. Moreover, as a response to the Supreme Court's recent admonishment in LaSalle Street that bankruptcy courts employ market tests more often when creditors dissent to a reorganization plan, the dilution mechanism provides a uniquely workable solution within the current statutory framework.

Number of Pages in PDF File: 82

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Date posted: September 14, 2000  

Suggested Citation

Adler, Barry E. and Ayres, Ian, A Dilution Mechanism for Valuing Corporations in Bankruptcy (September 2000). NYU, Center for Law and Business Research Paper No. 010; and Yale Law & Economics Research Paper No. 243. Available at SSRN: http://ssrn.com/abstract=241220 or http://dx.doi.org/10.2139/ssrn.241220

Contact Information

Barry E. Adler (Contact Author)
New York University School of Law ( email )
40 Washington Square South
New York, NY 10012-1099
United States
212-998-6660 (Phone)
212-995-4341 (Fax)
Ian Ayres
Yale University - Yale Law School ( email )
P.O. Box 208215
New Haven, CT 06520-8215
United States
203-432-7101 (Phone)
203-432-2592 (Fax)
Yale University - Yale School of Management
135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States
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