Agency Problems of Debt, Convertible Securities, and Deviations from Absolute Priority in Bankruptcy
It has been suggested that convertible debt can be used to reduce the tendency toward excessive risk taking in a firm that includes debt in its capital structure. We show that the ability of convertible debt to perform this function is greatly reduced if stakeholders can trade in derivative securities with payoffs contingent on the cash flows of the firm. We show, further, that bankruptcy courts can ensure the same result precisely by deviating from absolute priority. Our model explains two real-world phenomena; one, why bankruptcy law seems to be structured in such a way as to favor equity holders and facilitate deviations from absolute priority, and two, why small firms are more likely to use convertible debt. Copyright 1994 by the University of Chicago.
When requesting a correction, please mention this item's handle: RePEc:ucp:jlawec:v:37:y:1994:i:2:p:455-76. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Journals Division)
If references are entirely missing, you can add them using this form.