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optimal bankruptcy laws

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  • Povel, Paul

    (Sonderforschungsbereich 504)

Abstract

This paper studies optimal bankruptcy laws in a framework with asymmetric information. The key idea is that the financial distress of a firm is not observed by its lenders for quite a while. As early rescues are much cheaper than late rescues, it may pay if the creditors are forgiving in bankruptcy, thereby inducing the revelation of difficulties as early as possible. Either `tough' or `soft' bankruptcy laws can be optimal, depending on the parameters. This implies that mandatory one-size-fits-all bankruptcy procedures cannot be optimal. `Hybrid' procedures, which try to combine elements of `soft' and `tough' procedures, are found to be redundant, and possibly harmful. Absolute Priority Rules may be helpful as a part of `tough' procedures, but their introduction is (partly) inconsistent with the design of `soft' procedures. The paper also reinterprets much of the evidence on the performance of Chapter 11, the `rather soft' U.S. reorganisation procedure, questioning many negative conclusions.

Suggested Citation

  • Povel, Paul, 1998. "optimal bankruptcy laws," Sonderforschungsbereich 504 Publications 98-31, Sonderforschungsbereich 504, Universität Mannheim;Sonderforschungsbereich 504, University of Mannheim.
    • Handle: RePEc:xrs:sfbmaa:98-31
    Note: Financial Support from the Deutsche Forschungsgemeinschaft is gratefully acknowledged.
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