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

40 Pages Posted: 26 Nov 2018 Last revised: 25 Nov 2019

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 25, 2019

Abstract

In its reform of the U.S. Bankruptcy Code, 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 under Chapter 11 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 junior creditors are overcompensated and that the redemption option replaces one type of Absolute Priority Rule violations with another. Importantly, the redemption option aligns junior creditors' interests with those of shareholders, thereby increasing the incentives for risk-shifting. While the ABI reform reduces bankruptcy costs, it also increases the risk of liquidation.

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 25, 2019). Available at SSRN: https://ssrn.com/abstract=3281346 or http://dx.doi.org/10.2139/ssrn.3281346

Amira Annabi

Manhattan College ( email )

The O'Malley School of Business
Economics and Finance Department
Riverdale, NY 10471
United States

HOME PAGE: http://https://www.linkedin.com/in/amiraannabi/

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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