Bankruptcy's Endowment Effect

30 Pages Posted: 10 Dec 2016 Last revised: 14 Oct 2017

Date Written: December 8, 2016

Abstract

In this Essay, I respond to Professor Markell’s analysis of the recent controversy over the cramdown interest rate applied in corporate bankruptcies. I argue that the main source of controversy is a misperception that pervades much of bankruptcy law and scholarship. Namely, courts and scholars commonly assign undue importance to preserving creditors’ nonbankruptcy endowments, which is inconsistent with foundational bankruptcy policy.

I make the case here that the guiding principle for optimal bankruptcy design should not be the preservation of nonbankruptcy rights but rather should be the minimization of opportunistic behavior that reduces the net value of a firm. Applying this principle to the question of the cramdown interest rate, I show that an optimal rule — properly focused on the minimization of opportunistic behavior — supports a cramdown interest rate based on the prevailing market rates for similar loans. Along the way I also show that this approach is consistent with the Bankruptcy Code and the theoretical principles (although not the ultimate conclusion) that Professor Markell has advocated.

Suggested Citation

Casey, Anthony Joseph, Bankruptcy's Endowment Effect (December 8, 2016). Bankruptcy Developments Journal, Vol. 33, 2016; University of Chicago Coase-Sandor Institute for Law & Economics Research Paper No. 789. Available at SSRN: https://ssrn.com/abstract=2882885

Anthony Joseph Casey (Contact Author)

University of Chicago Law School ( email )

1111 E. 60th St.
Chicago, IL 60637
United States
773.702.9578 (Phone)

HOME PAGE: http://www.law.uchicago.edu/faculty/casey

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