Financial Contracts and the Legal Treatment of Informed Investors
Working Paper No. 99-10
42 Pages Posted: 29 Sep 1999
Date Written: August 1999
The authors explore the economic rationale for equitable subordination, a legal doctrine that permits a firm's claimants to seek to subordinate an informed investor's financial claim in bankruptcy court. Fear of equitable subordination is often cited as a reason that banks in the U.S. are wary of taking an active management role in their borrowing firms. The authors show that an optimally designed menu of claims for a large investor will include features that resemble equitable subordination. The authors' model provides a partial rationale for a financial system in which powerful creditors do not generally hold blended debt and equity claims.
JEL Classification: G20, G32,G33, K22, P50
Suggested Citation: Suggested Citation