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Ex Ante Costs of Violating Absolute Priority in Bankruptcy

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  • Lucian Arye Bebchuk

    (Harvard Law School and National Bureau of Economic Research)

Abstract

A basic question for the design of bankruptcy law concerns whether value should be divided in accordance with absolute priority. Research done in the past decade has suggested that deviations from absolute priority have beneficial ex ante effects. In contrast, this paper shows that ex post deviations from absolute priority also have negative effects on ex ante decisions taken by shareholders. Such deviations aggravate the moral hazard problem with respect to project choice-increasing the equityholders' incentive to favor risky projects-as well as with respect to borrowing and dividend decisions. Copyright The American Finance Association 2002.

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Bibliographic Info

Article provided by American Finance Association in its journal The Journal of Finance.

Volume (Year): 57 (2002)
Issue (Month): 1 (02)
Pages: 445-460

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Handle: RePEc:bla:jfinan:v:57:y:2002:i:1:p:445-460

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References

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  11. Brown, David T, 1989. "Claimholder Incentive Conflicts in Reorganization: The Role of Bankruptcy Law," Review of Financial Studies, Society for Financial Studies, vol. 2(1), pages 109-23.
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  13. Povel, Paul, 1999. "Optimal "Soft" or "Tough" Bankruptcy Procedures," Journal of Law, Economics and Organization, Oxford University Press, vol. 15(3), pages 659-84, October.
  14. Berkovitch, Elazar & Israel, Ronen & Zender, Jaime F., 1998. "The Design of Bankruptcy Law: A Case for Management Bias in Bankruptcy Reorganizations," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 33(04), pages 441-464, December.
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  16. Bebchuk, Lucian Arye, 2000. "Using options to divide value in corporate bankruptcy," European Economic Review, Elsevier, vol. 44(4-6), pages 829-843, May.
  17. Lucian Arye Bebchuk & Howard F. Chang, 1991. "Bargaining and the Division of Value in Corporate Reorganization," NBER Technical Working Papers 0097, National Bureau of Economic Research, Inc.
  18. Weiss, Lawrence A., 1990. "Bankruptcy resolution: Direct costs and violation of priority of claims," Journal of Financial Economics, Elsevier, vol. 27(2), pages 285-314, October.
  19. Warner, Jerold B, 1977. "Bankruptcy Costs: Some Evidence," Journal of Finance, American Finance Association, vol. 32(2), pages 337-47, May.
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  21. Lucian Arye Bebchuk, 1998. "Chapter 11," NBER Working Papers 6473, National Bureau of Economic Research, Inc.
  22. Michael C. Jensen, 1991. "Corporate Control And The Politics Of Finance," Journal of Applied Corporate Finance, Morgan Stanley, vol. 4(2), pages 13-34.
  23. Allan C. Eberhart & Lemma W. Senbet, 1993. "Absolute Priority Rule Violations and Risk Incentives for Financially Distressed Firms," Financial Management, Financial Management Association, vol. 22(3), Fall.
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