The Nature of the Bankrupt Firm: A Reply to Baird and Rasmussen's 'the End of Bankruptcy'
26 Pages Posted: 24 Apr 2003
In an article recently published in the Stanford Law Review Professors Douglas G. Baird and Robert K. Rasmussen assert that big-case bankruptcy reorganizations have "all but disappeared" and give three theoretical explanations. This reply provides empirical evidence that the assertion is wrong; reorganizations not only survive but are booming. It then explains how their theoretical explanations led Baird and Rasmussen to the wrong conclusion.
In their first explanation, Baird and Rasmussen note that modern firms have few firm-specific or dedicated assets. From that observation, they argue that the firms have no going concern value. This reply argues that the going concern value of bankrupt firms exists independently of the firm's assets and does not depend on their nature. Instead, going concern value inheres in the relationships among people and assets. Modern firms continue to generate those relationships and so continue to have substantial going concern value.
Baird and Rasmussen's second explanation relies on asserted recent advances in bankruptcy contracting. They claim those advances made it possible to deliver control rights dynamically to investors whose incentives match the interests of the firm. Through these contracts, creditors who are the residual owners of the firm are put in control of the firm, rendering reorganization superfluous. This reply notes that Baird and Rasmussen supply no description of the contracts involved. It also provides empirical evidence that the pattern of contracting claimed is impossible because no single class of residual owners exists in most bankrupt firms.
In their third explanation, Baird and Rasmussen argue that improvements in the market for firms have made sale as a going concern an effective substitute for reorganization. This reply explains why reorganizations would continue even if firms could be sold for their full going concern values.
Keywords: bankruptcy, reorganization, bankruptcy reorganization, corporate reorganization, bankruptcy contracting, residual owner, asset specificity, nature of the firm, liquidation
JEL Classification: G33, D23, G34, K12, K22, L51
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