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Solvency Tests

35 Pages Posted: 19 Sep 2006  

J.B. Heaton

Bartlit Beck Herman Palenchar & Scott LLP

Date Written: September 2006

Abstract

I explain the basic economic function of solvency tests and the relations among the three solvency tests applied in bankruptcy and corporate law. I also explain why solvency diagnoses can differ, depending on the test that is applied. While one of these tests - the ability to pay test - is probably best, it may suffer from significant measurement error in practice. Multiple solvency tests make sense because the costs of failing to detect insolvency when it exists exceed the costs of detecting insolvency when it does not exist.

Keywords: Insolvency, Bankruptcy, Fiduciary Duties, Creditors, Valuation

JEL Classification: G30, G33, K22

Suggested Citation

Heaton, J.B., Solvency Tests (September 2006). Available at SSRN: https://ssrn.com/abstract=931026 or http://dx.doi.org/10.2139/ssrn.931026

J.B. Heaton (Contact Author)

Bartlit Beck Herman Palenchar & Scott LLP ( email )

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