Contracting Externalities and Mandatory Menus in the U.S. Corporate Bankruptcy Code

50 Pages Posted: 22 Dec 2013 Last revised: 3 Mar 2015

See all articles by Antonio E. Bernardo

Antonio E. Bernardo

University of California, Los Angeles (UCLA) - Finance Area

Alan Schwartz

Yale Law School

Ivo Welch

University of California, Los Angeles (UCLA); National Bureau of Economic Research (NBER)

Date Written: December 1, 2014

Abstract

Our paper offers the first justification for the U.S. bankruptcy code, in which firms are not allowed to commit themselves ex-ante in their lending agreements either to (Chapter 7) liquidation or to (Chapter 11) reorganization in case of distress ex-post. If fire-sale liquidation imposes negative externalities on their peers, then firms can be collectively better off if they are all forced into a no-opt-out choice (a mandatory “menu”). This is the case even though they would individually want to commit themselves to liquidation, and it is collectively better for them than voluntary contract choice or mandatory liquidation. Our paper’s innovation is thus to show not when a later choice should be prohibited, but when a later choice should be mandatory. Equivalent analyses could justify when other ex-post choices should remain inalienable (not contractible).

Keywords: Bankruptcy, Opt-Out Choice, Chapter 11

JEL Classification: G33, D62, K12

Suggested Citation

Bernardo, Antonio E. and Schwartz, Alan and Welch, Ivo, Contracting Externalities and Mandatory Menus in the U.S. Corporate Bankruptcy Code (December 1, 2014). Available at SSRN: https://ssrn.com/abstract=2370722 or http://dx.doi.org/10.2139/ssrn.2370722

Antonio E. Bernardo

University of California, Los Angeles (UCLA) - Finance Area ( email )

Los Angeles, CA 90095-1481
United States
310-825-2198 (Phone)
310-206-5455 (Fax)

Alan Schwartz

Yale Law School ( email )

P.O. Box 208215
New Haven, CT 06520-8215
United States
203-432-4030 (Phone)
203-432-8260 (Fax)

Ivo Welch (Contact Author)

University of California, Los Angeles (UCLA) ( email )

110 Westwood Plaza
C519
Los Angeles, CA 90095-1481
United States
310-825-2508 (Phone)

HOME PAGE: http://www.ivo-welch.info

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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