The Bankruptcy Decision

Abstract

Thispaper investigates the circumstances under which a firm will be forced into bankruptcy. The model developed can be viewed as part of a largerframework which would be necessary to address the question of optimalfinancial policy in a world of taxation, bankruptcy costs, investment and depreciation, uncertainty, etc. The model focuses on the conflicts of interest among various claimants to the assets and income flows of the firm (the stockholders, bondholders, and bank lenders). We derive conditions under which the necessary funds for continuation will not be forthcoming and illustrate the importance of the liquidity of the assets and the maturity structure of the debt in staving off bankruptcy. Several examples highlight the major conclusions of the paper. The conditions for bankruptcy, which have some intuitive appeal, are more complex than those appearing in the previous literature. The latter part of the paper considers merger with a healthy company as an alternative to bankruptcy. We show that the tax system has an important effect on the choice between merger and bankruptcy. This work was supported by the Alfred P. Sloan Foundation. We would like to thank Alvin Kievorick and two anonymous referees fortheir helpful comments onan earlierversion ofthis paper. 1 Most significantly, perhaps, Modigliani and Miller (1958). 437 '~You can think of them as many small individual investors.

2. Trends in Transportation Employee Injuries Since Economic Deregulation

“…There is a theoretical literature that indicates that firms close to bankruptcy may also be motivated to cheat their customers by reducing safety (Bulow and Shoven, 1978). These firms can reduce expenses by cutting maintenance and training, yet can declare bankruptcy to protect against claims in the event that a major crash occurs.…”

Insolvency administrator’s incentives and the tradeoff between creditor satisfaction and efficiency in bankruptcy procedures

“…Further studies analyse the influence of biased judges (Bris et al 2005;Baird 1986) or the quality and judicial discretion of judges on the ex post outcome of a bankruptcy procedure (Ayotte and Yun 2007;Bernhardt and Nosal 2004). Another issue discussed in the literature is the conflict of interest among multiple creditors (Blazy and Chopard 2004) or the problems due to multiple classes of creditors (Bulow and Shoven 1978;White 1989;Gertner and Scharfstein 1991). This paper addresses the individual incentives of a better-informed insolvency administrator as an additional source of filtering failure.…”

Debt Restructuring with Multiple Creditors and the Role of Exchange Offers

“…Granting sufficient debt forgiveness to an insolvent firm requires a high degree of coordination among creditors, and coordination is difficult to achieve when creditors are many. A number of authors have suggested that the larger the number of creditors the more difficult is debt renegotiation (Bulow and Shoven, 1978;White, 1980 and, and empirical evidence shows that firms with more layers of creditors are less likely to restructure their debts out of court . The concern about losses of firm value in financial distress has led a number of countries to introduce special bankruptcy statutes which, by weakening creditors' contractual rights, make it easier for indebted firms to obtain debt forgiveness (Mitchell, 1990).…”