Bankruptcy Decision Making

31 Pages Posted: 13 Jun 2001 Last revised: 30 Sep 2016

See all articles by Douglas G. Baird

Douglas G. Baird

University of Chicago Law School

Edward R. Morrison

Columbia Law School


When a firm encounters financial distress, there is a significant possibility that, at some point, the firm itself should be shut down and its assets put to a better use. But Chapter 11 and indeed all market-mimicking reorganization regimes other than a speedy auction entrust the shutdown decision to a bankruptcy judge who lacks information and expertise, as well as the ability to control the timing of her decisions. Understanding the costs of entrusting the shutdown decision to a bankruptcy judge is central to assessing any law of corporate reorganizations. This paper models the shutdown decision as the exercise of a real option. The model suggests that the shutdown decision may loom so large in the early parts of the bankruptcy case that it erases any significant difference between Chapter 11 and many alternative market-mimicking regimes. All these regimes take more time than mandatory auctions and thus increase the cost of taking the shutdown decision away from a market actor. Moreover, the real option itself gives parties an incentive to withhold information. Only a system of mandatory auctions both limits the amount of time the shutdown option resides with an inexpert decisionmaker and forces insiders to give that decisionmaker sufficient information to value the option while it is in her hands.

Suggested Citation

Baird, Douglas G. and Morrison, Edward R., Bankruptcy Decision Making. Journal of Law, Economics, and Organization, Vol. 17, pp. 356-372, 2001, Available at SSRN:

Douglas G. Baird (Contact Author)

University of Chicago Law School ( email )

1111 E. 60th St.
Chicago, IL 60637
United States
773-702-9571 (Phone)
773-702-0730 (Fax)

Edward R. Morrison

Columbia Law School ( email )

435 West 116th Street
New York, NY 10025
United States

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