Tax Claims, Government Priority, Absolute Priority and the Resolution of Financial Distress
26 Pages Posted: 11 Sep 2014 Last revised: 1 Jun 2016
Date Written: March 25, 2016
We present a model of an insolvent firm that may take advantage of a "soft-touch" government creditor in order to buy time before filing for reorganization, behavior we refer to as "claims substitution." Parameters in the model reflect the enforcement of absolute priority and government priority in bankruptcy. We show that deviations from absolute priority reduce the incentive for claims substitution. We also show that strict government priority is economically efficient. We discuss the implications of our findings for bankruptcy law reform, especially with respect to the priority of tax claims in bankruptcy and the enforcement of absolute priority.
Keywords: financial reorganization, tax claims, absolute priority, bankruptcy law
JEL Classification: G33, G38, K22
Suggested Citation: Suggested Citation