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Who Should Pay for Bankruptcy Costs?

  • Arturo Bris
  • Alan Schwartz
  • Ivo Welch

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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File URL: http://www.journals.uchicago.edu/cgi-bin/resolve?id=doi:10.1086/430766
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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
Contact details of provider: Web page: http://www.journals.uchicago.edu/JLS/

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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. 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.
  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. 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.
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