Ex Ante Costs of Violating Absolute Priority in Bankruptcy

25 Pages Posted: 21 Jul 2001 Last revised: 10 May 2009

Lucian A. Bebchuk

Harvard Law School; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR) and European Corporate Governance Institute (ECGI)

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Abstract

A basic question for the design of bankruptcy law concerns whether value should be divided in accordance with absolute priority. Research done in the past decade has suggested that deviations from absolute priority have beneficial ex ante effects. In contrast, this paper shows that ex post deviations from absolute priority also have negative effects on ex ante decisions taken by shareholders. Such deviations aggravate the moral hazard problem with respect to project choice - increasing the equityholders' incentive to favor risky projects - as well as with respect to borrowing and dividend decisions.

Keywords: Bankruptcy, Chapter 11, corporate reorganizations, workouts, absolute priority, moral hazard, asset dilution, claim dilution

JEL Classification: G33, K20, K22

Suggested Citation

Bebchuk, Lucian A., Ex Ante Costs of Violating Absolute Priority in Bankruptcy. Journal of Finance, Vol. 57, pp. 445-460, 2002; Harvard Law and Economics Discussion Paper No. 328, 2001. Available at SSRN: https://ssrn.com/abstract=277428 or http://dx.doi.org/10.2139/ssrn.277428

Lucian A. Bebchuk (Contact Author)

Harvard Law School ( email )

Cambridge, MA 02138
United States
617-495-3138 (Phone)
617-812-0554 (Fax)

HOME PAGE: http://www.law.harvard.edu/faculty/bebchuk/

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR) and European Corporate Governance Institute (ECGI)

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