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The End of Bankruptcy

Douglas G. Baird

University of Chicago Law School

Robert K. Rasmussen

University of Southern California Gould School of Law

U Chicago Law & Economics, Olin Working Paper No. 173; Vanderbilt Law and Economics Research Paper No. 02-23

The law of corporate reorganizations is conventionally justified as a way to preserve a firm's going-concern value: Specialized assets in a particular firm are worth more together in that firm than anywhere else. This paper shows that this notion is mistaken. Its flaw is that it lacks a well-developed understanding of the nature of a firm. Initially, it is easy to confuse size with specialization and overstate the extent to which assets are dedicated to a particular enterprise. Even when such dedicated assets exist, they often do not need to stay in the same firm. As Coase taught us, as the costs of contracting go down, so too does the value of keeping assets in a particular firm.

But even when specialized assets must be kept inside a firm, two other forces limit the need for a traditional law of corporate reorganizations. Capital structures are increasingly designed with financial distress in mind. For these firms, control rights shift from one set of investors to another as the firm encounters difficulty. Such firms either never file for bankruptcy, or, if they do, it is only to vindicate the pre-determined allocation of control rights. Even where control rights are not sensibly allocated, a quick sale of the firm restores order. When firms can be sold as going concerns, the need for the traditional negotiated plan of reorganization disappears.

The vast majority of firms in financial distress never enter bankruptcy. Today the Chapter 11 of a large firm is an auction of the assets, followed by litigation over the proceeds. To the extent we understand the law of corporate reorganizations as providing a collective forum in which creditors and their common debtor fashion a future for a firm that would otherwise be torn apart by financial distress, we may safely conclude that its era has come to an end.

Number of Pages in PDF File: 46

Keywords: corporate reorganization, firm valuation, Chapter 11

JEL Classification: K2, G30, G32, G33, G34

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Date posted: December 13, 2002  

Suggested Citation

Baird, Douglas G. and Rasmussen, Robert K., The End of Bankruptcy. Stanford Law Review, Vol. 55, 2002. Available at SSRN: https://ssrn.com/abstract=359241 or http://dx.doi.org/10.2139/ssrn.359241

Contact Information

Douglas G. Baird (Contact Author)
University of Chicago Law School ( email )
1111 E. 60th St.
Chicago, IL 60637
United States
773-702-9571 (Phone)
773-702-0730 (Fax)

Robert K. Rasmussen
University of Southern California Gould School of Law ( email )
699 Exposition Boulevard
Los Angeles, CA 90089-0071
United States
213-740-6473 (Phone)
213-740-5502 (Fax)

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