Could Chapter 11 Redeem Itself? Wealth and Welfare Effects of the Redemption Option

35 Pages Posted: 26 Nov 2018

See all articles by Amira Annabi

Amira Annabi

Manhattan College; Manhattan College

Michèle Breton

HEC Montreal - Department of Management Sciences

Pascal Francois

HEC Montreal - Department of Finance

Date Written: November 6, 2018

Abstract

In its reform of the US bankruptcy procedure, the American Bankruptcy Institute (ABI) is proposing to grant a redemption option to junior creditors and let them exit the bargaining process. A game-theoretic, continuous-time model of the leveraged firm is developed to assess the wealth transfers and welfare impacts of such an amendment. After fitting the model to the current outcomes of Chapter 11, numerical experiments show that the compensation to junior creditors is too high and that the redemption option replaces one type of Absolute Priority Rule violations with another. Experiments also show that, while the ABI reform reduces bankruptcy costs, it also increases the frequency of liquidation. We conclude that it may be advisable to revise the design of the redemption and to offer it on a case-by-case basis.

Keywords: Chapter 11, bankruptcy, APR violation, recovery, game theory, dynamic programming

JEL Classification: C61, C7, G33, G34

Suggested Citation

Annabi, Amira and Breton, Michèle and Francois, Pascal, Could Chapter 11 Redeem Itself? Wealth and Welfare Effects of the Redemption Option (November 6, 2018). Available at SSRN: https://ssrn.com/abstract=3281346 or http://dx.doi.org/10.2139/ssrn.3281346

Amira Annabi

Manhattan College ( email )

Riverdale, NY 10471
United States

Manhattan College ( email )

Manhattan College Parkway
Riverdale, NY 10471
United States

Michèle Breton

HEC Montreal - Department of Management Sciences ( email )

Montreal, Quebec H3T 2A7
Canada
514-340-6490 (Phone)
514-340-5634 (Fax)

Pascal Francois (Contact Author)

HEC Montreal - Department of Finance ( email )

3000 Chemin de la Cote-Sainte-Catherine
Montreal, Quebec H3T 2A7
Canada
514-340-7743 (Phone)
514-340-5632 (Fax)

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