Working Paper: CEPR ID: DP2914
Authors: Lucian Arye Bebchuk
Abstract: A basic question for the design of bankruptcy law concerns whether value should be divided in accordance with absolute priority. Research done in the past decade has suggested that deviations from absolute priority have beneficial ex ante effects. In contrast, this Paper shows that ex post deviations from absolute priority also have negative effects on ex ante decisions taken by shareholders. Such deviations aggravate the moral hazard problem with respect to project choice increasing the equityholders' incentive to favour risky projects as well as with respect to borrowing and dividend decisions.
Keywords: absolute priority; asset dilution; bankruptcy; chapter 11; claim dilution; corporate reorganizations; moral hazard; workouts
JEL Codes: G33; K20; K22
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| ex post deviations from absolute priority (AP) (G33) | equityholders favor riskier projects (G32) |
| equityholders favor riskier projects (G32) | inefficient management decisions regarding investments (G11) |
| ex post deviations from absolute priority (AP) (G33) | inefficient management decisions regarding investments (G11) |
| inefficient management decisions regarding investments (G11) | increased nominal interest rates (E43) |
| increased nominal interest rates (E43) | project choice favors riskier investments (G11) |