Optimal Judicial Decision Making in Corporate Bankruptcy Cases

Abstract

The fundamental question in any corporate bankruptcy case is whether the bankrupt firm should be liquidated or continued (and how). This paper provides a generic model as to how this question can be addressed by the bankruptcy judge who does not know at the outset whether the management of the firm is of efficient type (continuation value exceeds liquidation value) or of inefficient type (liquidation value exceeds continuation value). A screening mechanism is proposed such that efficiency is preserved in bankruptcy decision making. A first best result in contract theory is obtained and applicability in actual corporate bankruptcy decision makings discussed.

Keywords: Corporate Bankruptcy Law, Asymmetric Information, Judicial Decision Making

JEL Classification: G3, K4