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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.

Suggested Citation

  • Arturo Bris & Alan Schwartz & Ivo Welch, 2005. "Who Should Pay for Bankruptcy Costs?," The Journal of Legal Studies, University of Chicago Press, vol. 34(2), pages 295-341, June.
  • Handle: RePEc:ucp:jlstud:v:34:y:2005:p:295-341 DOI: 10.1086/430766

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    References listed on IDEAS

    1. 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.
    2. Povel, Paul, 1999. "Optimal "Soft" or "Tough" Bankruptcy Procedures," Journal of Law, Economics and Organization, Oxford University Press, vol. 15(3), pages 659-684, October.
    3. Welch, Ivo, 1997. "Why Is Bank Debt Senior? A Theory of Asymmetry and Claim Priority Based on Influence Costs," Review of Financial Studies, Society for Financial Studies, vol. 10(4), pages 1203-1236.
    4. Altman, Edward I, 1984. " A Further Empirical Investigation of the Bankruptcy Cost Question," Journal of Finance, American Finance Association, vol. 39(4), pages 1067-1089, September.
    5. Warner, Jerold B, 1977. "Bankruptcy Costs: Some Evidence," Journal of Finance, American Finance Association, vol. 32(2), pages 337-347, May.
    6. 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 219-226, March.
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    Cited by:

    1. Arturo Bris & Ivo Welch, 2005. "The Optimal Concentration of Creditors," Journal of Finance, American Finance Association, vol. 60(5), pages 2193-2212, October.
    2. Dinev, Nikolay, 2017. "Voluntary Bankruptcy as Preemptive Persuasion," Economics Series 334, Institute for Advanced Studies.
    3. Alan Schwartz, "undated". "A Normative Theory of Business Bankruptcy," American Law & Economics Association Annual Meetings 1037, American Law & Economics Association.
    4. John Armour, 2006. "Should we redistribute in insolvency," Working Papers wp319, Centre for Business Research, University of Cambridge.
    5. Edward R. Morrison, 2007. "Bankruptcy Decision Making: An Empirical Study of Continuation Bias in Small-Business Bankruptcies," Journal of Law and Economics, University of Chicago Press, vol. 50, pages 381-419.
    6. 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.
    7. repec:spr:busres:v:10:y:2017:i:2:d:10.1007_s40685-017-0047-x is not listed on IDEAS
    8. 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.

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