Optimal 'Soft' or 'Tough' Bankruptcy Procedures

Posted: 20 Oct 1999

See all articles by Paul Povel

Paul Povel

University of Houston - Department of Finance, C.T. Bauer College of Business

Abstract

This article describes optimal bankruptcy laws in a framework with asymmetric information. The key idea is that the financial distress of a firm is not observed by its lenders for quite a while. As early rescues are much cheaper than late rescues, it may pay if the creditors are forgiving in bankruptcy, thereby inducing the revelation of difficulties as early as possible. Either 'tough' or 'soft' bankruptcy laws can be optimal, depending on the parameters. This implies that mandatory one-size-fits-all bankruptcy procedures cannot be optimal. 'Hybrid' procedures, which try to combine elements of soft and tough procedures, are found to be redundant, and possibly harmful. Absolute priority rules may be helpful as a part of tough procedures, but their introduction is (partly) inconsistent with the design of soft procedures. The article also reinterprets much of the evidence on the performance of Chapter 11, the 'rather soft' U.S. reorganization procedure, questioning many negative conclusions.

Suggested Citation

Povel, Paul, Optimal 'Soft' or 'Tough' Bankruptcy Procedures. Available at SSRN: https://ssrn.com/abstract=172528

Paul Povel (Contact Author)

University of Houston - Department of Finance, C.T. Bauer College of Business ( email )

University of Houston
334 Melcher Hall
Houston, TX 77204
United States
713-743-4759 (Phone)

HOME PAGE: http://www.bauer.uh.edu/povel

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