Bankruptcy Law and the Market for Corporate Influence: Extending the Creditors' Bargain to Distress Investors *

Abstract

The canonical view of bankruptcy law is that it solves a market failure by imposing a collective choice process that supplants the market. We propose that a bankruptcy law instead catalyzes the market if the collective choice process provides scope for rent seeking. Based on a model in which coordination failure is the key friction, as in the canonical theory, we argue that such a law induces activist investing which improves the efficiency of distressed restructuring. We interpret the evolution of Chapter 11 and its surrounding market environment through this lens.

Keywords: Distress investing, claims trading, bankruptcy law, free-rider problem, vultures, Investor activism

JEL Classification: G20, G32