Debt Capacity and Fraudulent Conveyance Law
Journal of Financial Intermediation, Vol. 9, pp. 169-183 (2000).
30 Pages Posted: 9 May 1998 Last revised: 17 Feb 2019
Date Written: August 1, 1998
Financial contracts break down in some states of the world, creating a role for non-contractual legal rules to span them and solve incomplete contracting problems. This paper shows how fraudulent conveyance law plays this role for debt contracts, forbidding asset transfers for less than "reasonably equivalent value" that leave the borrower insolvent. This increases debt capacity for borrowers and ensures that the possibility of fraudulent asset transfers does not deter socially optimal investment. Fraudulent conveyance law increases debt capacity most dramatically for firms whose assets have very high liquidation values, providing the legal foundation necessary to support the standard economic insight that high liquidation value implies high debt capacity. Recognizing the role non-contractual legal mechanisms play can improve the predictive power of financial contracting models, especially those that erroneously assume the unhindered possibility of fraudulent asset transfers (theft) by managers.
Note: The newest version of this paper, titled "Incomplete Financial Contracts and Non-Contractual Legal Rules: The Case of Debt Capacity and Fraudulent Conveyance Law" is downloaded from this web page.
JEL Classification: G30, G32, G33
Suggested Citation: Suggested Citation