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Who Should Pay for Bankruptcy Costs?

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  • Arturo Bris
  • Alan Schwartz
  • Ivo Welch

Abstract

The fees of professionals (financial advisors, lawyers, accountants) are a substantial fraction of bankruptcy costs. Scholars have considered how best to reduce these costs but have not considered how they should be allocated among creditors. Creditors can spend redistributionally (to violate or uphold absolute priority) or productively (to increase the value of the bankrupt firm). An efficient bankruptcy cost allocation scheme should discourage redistributional and encourage productive creditor spending. We consider the desirability of various allocation schemes in a model in which senior and junior creditors can engage in both types of spending. We show that (1) the current U.S. cost allocation system is unsatisfactory because the scheme partially reimburses junior expenses for professionals but does not reimburse senior expenses and (2) a cost allocation scheme that approaches the first-best solution and is implementable would delegate the issue of professionals’ cost reimbursement to the debtor in possession.

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Bibliographic Info

Article provided by University of Chicago Press in its journal The Journal of Legal Studies.

Volume (Year): 34 (2005)
Issue (Month): 2 (06)
Pages: 295-341

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Handle: RePEc:ucp:jlstud:v:34:y:2005:p:295-341

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References

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  1. Warner, Jerold B, 1977. "Bankruptcy Costs: Some Evidence," Journal of Finance, American Finance Association, vol. 32(2), pages 337-47, May.
  2. Altman, Edward I, 1984. " A Further Empirical Investigation of the Bankruptcy Cost Question," Journal of Finance, American Finance Association, vol. 39(4), pages 1067-89, September.
  3. 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.
  4. Ang, James S & Chua, Jess H & McConnell, John J, 1982. " The Administrative Costs of Corporate Bankruptcy: A Note," Journal of Finance, American Finance Association, vol. 37(1), pages 219-26, March.
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Cited by:
  1. Alan Schwartz, . "A Normative Theory of Business Bankruptcy," American Law & Economics Association Annual Meetings 1037, American Law & Economics Association.
  2. Douglas Baird & Arturo Bris & Ning Zhu, 2007. "The Dynamics of Large and Small Chapter 11 Cases: An Empirical Study," Yale School of Management Working Papers amz2524, Yale School of Management, revised 01 Sep 2009.
  3. Fan, Joseph P.H. & Huang, Jun & Zhu, Ning, 2013. "Institutions, ownership structures, and distress resolution in China," Journal of Corporate Finance, Elsevier, vol. 23(C), pages 71-87.
  4. John Armour, 2006. "Should we redistribute in insolvency," ESRC Centre for Business Research - Working Papers wp319, ESRC Centre for Business Research.

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