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Financial contracts and the legal treatment of informed investors

Author Info

Listed author(s):
  • Mitchell Berlin
  • Loretta J. Mester

Abstract

The authors explore the economic rationale for equitable subordination, a legal doctrine that permits a firm's claimants to seek to subordinate an informed investor's financial claim in bankruptcy court. Fear of equitable subordination is often cited as a reason that banks in the U.S. are wary of taking an active management role in their borrowing firms. The authors show that an optimally designed menu of claims for a large investor will include features that resemble equitable subordination. The authors' model provides a partial rationale for a financial system in which powerful creditors do not generally hold blended debt and equity claims.

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Paper provided by Federal Reserve Bank of Philadelphia in its series Working Papers with number 99-8.

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Date of creation: 1999
Handle: RePEc:fip:fedpwp:99-8
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Keywords: Bankruptcy;

This paper has been announced in the following NEP Reports:

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  19. Mathias Dewatripont & Jean Tirole, 1994. "A Theory of Debt and Equity: Diversity of Securities and Manager-Shareholder Congruence," The Quarterly Journal of Economics, Oxford University Press, vol. 109(4), pages 1027-1054.
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