The Design of Bankruptcy Law: A Case for Management Bias in Bankruptcy Reorganizations

Posted: 15 Sep 1999

See all articles by Elazar Berkovitch

Elazar Berkovitch

Interdisciplinary Center, Herzliyah

Ronen Israel

Interdisciplinary Center, Herzliyah

Jaime F. Zender

University of Colorado at Boulder - Department of Finance

Date Written: September 1994

Abstract

An incomplete contracting environment, bankruptcy is considered to be a renegotiation of the firm's financial contracts. An optimal bankruptcy law is derived as optimal restrictions on the environment within which the claimants to a distressed firm bargain. The law is used as a commitment device to ensure actions that are ex ante optimal but not subgame perfect. It is shown that the bankruptcy court can use two types of mechanism to implement the optimal bankruptcy outcome: direct restrictions on the bargaining game between the claimants, and the use of a "restricted auction." In both cases, the restrictions prevent the strategic use of bankruptcy by firms not in financial distress, provide truthful revelation of information so that distress results in an ex post efficient allocation of resources, and most importantly establish a bias towards the manager in reorganizations that provides correct ex ante decision making incentives.

JEL Classification: G33

Suggested Citation

Berkovitch, Elazar and Israel, Ronen and Zender, Jaime F., The Design of Bankruptcy Law: A Case for Management Bias in Bankruptcy Reorganizations (September 1994 ). Available at SSRN: https://ssrn.com/abstract=5814

Elazar Berkovitch

Interdisciplinary Center, Herzliyah ( email )

P.O. Box 167
Herzliya, 46150
Israel

Ronen Israel (Contact Author)

Interdisciplinary Center, Herzliyah ( email )

P.O. Box 167
Herzliya, 4610101
Israel
972-9-9527306 (Phone)

Jaime F. Zender

University of Colorado at Boulder - Department of Finance ( email )

Boulder, CO 80309
United States
303-554-1665 (Phone)
303-492-4689 (Fax)

HOME PAGE: http://www-bus.colorado.edu/faculty/Zender/

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