47 Pages Posted: 31 Jan 2008 Last revised: 3 Jul 2009
Date Written: July 9, 2008
We analyze a sample of large privately and publicly held businesses that filed Chapter 11 bankruptcy petitions during 2001. We find pervasive creditor control. In contrast to traditional views of Chapter 11, equityholders and managers exercise little or no leverage during the reorganization process: Seventy percent of CEOs are replaced in the two years before a bankruptcy filing; very few reorganization plans (at most eight percent) deviate from the absolute priority rule in order to distribute value to equityholders. Senior lenders exercise significant control through stringent covenants contained in DIP loans, such as line-item budgets. Unsecured creditors gain leverage through objections and other court motions. We also find that bargaining between secured and unsecured creditors can distort the reorganization process. A Chapter 11 case is significantly more likely to result in a sale if secured lenders are oversecured, consistent with a secured creditor-driven fire-sale bias. It is much less likely when these lenders are undersecured or when the firm has no secured debt at all. Our results suggest that the advent of creditor control has not eliminated the fundamental inefficiency of the bankruptcy process: resource allocation questions (whether to sell or reorganize a firm) are ultimately confounded with distributional questions (how much each creditor will receive), due to conflict among creditor classes.
Keywords: Bankruptcy, corporate reorganization, Chapter 11, creditor control, DIP lending, creditor conflict
JEL Classification: G33, G34, K29
Suggested Citation: Suggested Citation
Ayotte, Kenneth and Morrison, Edward R., Creditor Control and Conflict in Chapter 11 (July 9, 2008). Columbia Law and Economics Research Paper No. 321; Northwestern Law & Econ Research Paper No. 08-16. Available at SSRN: https://ssrn.com/abstract=1081661 or http://dx.doi.org/10.2139/ssrn.1081661