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http://hdl.handle.net/2451/26678
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| Title: | Design of Efficient Bankruptcy Mechanisms |
| Authors: | Nagarajan, S. |
| Issue Date: | 1997 |
| Series/Report no.: | FIN-97-007 |
| Abstract: | This paper models efficient design of bankruptcy mechanisms under
multi-lateral asymmetric information as a problem involving the
joint-reallocation of i) existing debt claims of differing priority
against the firm, and ii) the rights to control and run the firm in the
event of a reorganization – when some or all claimholders may have
private information. Such a unified approach yields a key insight
– namely, that corporate governance structures, especially the
allocation of control rights, and not just the repackaging of existing
debt claims, are the main determinant of efficiency in the resolution of
bankruptcy. Applying the mechanism design technique allows us to answer
the question of if and when it is possible to efficiently reorganize or
liquidate a financially distressed firm, in the context of a large
family of bankruptcy games. It is shown that there exist incentive
compatible bankruptcy mechanisms that are efficient not only ex ante,
but also ex post. These are then characterized, and show to have the
following properties: i) Conventional governance structures may not be
efficient, and control rights may have to be allocated to minority
share-holders; ii) There is no trade off between ex ante and ex post
efficiency in resolving bankruptcy; iii) Only aggregate debt levels, not
individual debt claims, matter; iv) All the creditors’ ex ante
contractual rights will be respected, and hence cram-down is
unnecessary; v) Efficient mechanisms are also strongly
renegotiation-proof, in the sense that the claimholders will have no
incentive to renegotiate their settlement ex post. These results hold
for any type of bankruptcy game, whether bankruptcy is involuntary or
strategic for any firm with any set of existing debt claims, and are
independent of distributional assumptions. |
| URI: | http://hdl.handle.net/2451/26678 |
| Appears in Collections: | Finance Working Papers
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