The following nine bankruptcy-related working papers can be downloaded from the Social Science Research Network:
Columbia Business School’s Kenneth Ayotte and Stav Gaon, Asset-Backed Securities: Costs and Benefits of Bankruptcy Remoteness
Yale School of Management’s Arturo Bris, Ivo Welch and Ning Zhu: The Costs of Bankruptcy
Purdue University Business School’s Diane K. Denis and NYU’s Business School’s Kimberly J. Rodgers, Chapter 11: Duration, Outcome, and Post-Reorganization Performance
Quinnipiac University Law School’s Stephen G. Gilles, The Judgment-Proof Society
Independent Consultant Michael Nwogugu, Decision-making, Risk and Corprate Governance: A Critique of Bankruptcy/Recovery Prediction Models
Duke University’s Steven L. Schwarcz, The Easy Case for the Priority of Secured Claims in Bankruptcy
Lawyer Michael St. James, Why Bad Things Happen in Large Chapter 11 Cases: Some Thoughts about Courting Failure
Wisconsin Law School’s Bernard Trujillo, Patterns in a Complex System: An Empirical Study of Valuation in Business Bankruptcy Cases
Boston College Law School’s Catharine P. Wells, Who Owns the Local Church? A Pressing Issue for Dioceses in Bankruptcy
Abstracts for each of these working papers follow:
Kenneth Ayotte and Stav Gaon, Asset-Backed Securities: Costs and Benefits of Bankruptcy Remoteness:
This paper focuses on a key property of asset-backed securities (ABS); namely, that ABS are designed to achieve bankruptcy remoteness of the securitized assets from the borrowing firm. This provides lenders with maximal protection from dilution in bankruptcy that is not available with other contracts, such as secured debt. ABS can have real effects in allowing firms to commit to more efficient investment decisions in bankruptcy. We show that securitization of replaceable assets, such as accounts receivable, prevents inefficient continuation in bankruptcy, but securitization of necessary assets can lead to inefficient liquidations. In these circumstances, secured debt and/or leases can be preferred.
We provide empirical support for the importance of bankruptcy remoteness in ABS contracts using a controversial decision in the Chapter 11 bankruptcy of LTV Steel, in which a securitization contract was unexpectedly treated as a secured loan. Using a difference-in-differences approach, we find that ABS spreads for securitizers eligible for Chapter 11 increased significantly more than spreads for insured bank securitizers, who are not Chapter 11-eligible, in the period following the LTV filing. The results demonstrate that the creditor protection provided by bankruptcy remoteness is indeed valuable and priced in financial markets.
Arturo Bris, Ivo Welch and Ning Zhu: The Costs of Bankruptcy:
Our paper explores a comprehensive sample of small and large corporate bankruptcies in Arizona and New York from 1995-2001. We find that bankruptcy costs are very heterogeneous and sensitive to measurement method. Still, Chapter 7 liquidations appear no faster or cheaper (in terms of direct expense) than Chapter 11 bankruptcies. But Chapter 11 seems to preserve assets better, and thereby allows creditors to recover relatively more. Our paper also provides a large number of further empirical regularities.
Diane K. Denis and Kimberly J. Rodgers, Chapter 11: Duration, Outcome, and Post-Reorganization Performance:
We find that among firms that file Chapter 11 those that are smaller, have better operating performance, and are in higher-operating-margin industries spend less time in Chapter 11. Firms are more likely to emerge as going concerns and to achieve positive post-reorganization profitability if they significantly reduce assets and liabilities while in Chapter 11. Higher pre-bankruptcy industry-adjusted operating margins and improvements in margin are associated with post-reorganization profitability but do not impact the decision to reorganize. These results reveal characteristics and actions associated with successful reorganizations. Furthermore, they suggest that Chapter 11 allows promising firms to successfully reorganize.
Stephen G. Gilles, The Judgment-Proof Society:
Judgment-proof tortfeasors – individuals who lack sufficient collectible income and assets to pay for the torts they commit – are not deterred by the threat of tort liability and are not accountable in corrective justice. Although the judgment-proof problem is frequently alluded to in torts scholarship, the causes and pervasiveness of that problem have received little attention. This article argues that much of the judgment-proof problem is attributable to legal rules that enable uninsured and underinsured individuals to escape tort liability by sheltering their income and assets from collection. These legal barriers to collecting tort judgments include limits on wage garnishment, homestead exemptions, retirement-plan exemptions, discharge in bankruptcy, spendthrift trusts, offshore asset protection trusts, and more. Of course, indigent persons would be judgment-proof even without these rules, because they have so few assets and so little income. Contrary to the myth of personal tort liability that is standard in torts scholarship and teaching, however, these legal rules enable millions of working-class, middle-class, and affluent people to be (or become) judgment-proof despite the fact that they have steady incomes and significant assets that could be used to satisfy a tort judgment. The article describes the most important of these judgment-proofing rules in depth, demonstrates that they seriously undermine the deterrence and corrective justice goals of tort law, argues that they lack any persuasive justification, proposes specific reforms to reduce the judgment-proof problem, and evaluates the political feasibility of this agenda. It also evaluates the intriguing role of liability insurance as a response to the residual threat of personal tort liability, and suggests ways in which individuals could be induced (or required) to purchase more liability insurance in order to ameliorate the judgment-proof problem.
Purpose: The purposes of this article are: (a) to evaluate and critique models of bankruptcy/recovery risk; (d) to identify relevant elements of bankruptcy prediction and recovery prediction models.
Design/Methodology/Approach: The author critiques existing academic work on bankruptcy risk, recovery risk, decision making.
Findings: (a) All existing bankruptcy preiction and recovery prediction models are inaccurate, b) the models were developed using highly questionable methods and data, and are impractical; (c) risk and decision making are better quantified and modeled using a mix of situation-specific dynamic, quantitative, and qualitative factors; (d) bankruptcy models and recovery models do not incorporate the many psychological, legal, liquidity, knowledge, and price-dynamic factors inherent in capital markets, financial distress and asset prices, and thus, are not useful and accurate in many asset markets, particularly those outside the U.S. and in emerging market countries.
Research Limitations/Implications: Areas for further research include: (a) development of dynamic bankruptcy/recovery prediction models that incorporate asset-market psychology, ramifications of bankruptcy laws/rules, knowledge differences among market participants, and psychology.
Practical Implications: (a) bankrucpty/recovery analysis and Decision making are multi-criteria processes that typically require some processing of information, and thus cannot be defined accurately by rigid quantitative models; (b) existing bankruptcy prediction and recovery prediction (PROBIT, LOGIT, MDA, Neural nets, etc.) are inaccurate�many international banks, bankruptcy judges, central banks, government agencies, and financial institutions use these models for risk management, capital allocation, portfolio management, and investments, and thus the international financial system may be compromised.
Originality/Value: The critiques, ideas, and new theories in the article were all developed by the author. The issues discussed in the article are relevant to government regulators, banks, bankruptcy judges, companies,management science/operations research professionals, etc.
Steven L. Schwarcz, The Easy Case for the Priority of Secured Claims in Bankruptcy:
For years, scholars have questioned the efficiency of secured debt, many suggesting that it transfers uncompensated risk to unsecured creditors. This Article argues that the most important form of secured debt, new money credit secured by collateral, tends to create value for unsecured creditors as well as for the debtor. Prior writing on the value of secured debt ignores the distinction between the use and the availability (and subsequent use only if needed) of secured credit. As a result, previous models of secured debt erroneously assumed that a debtor that can borrow on an unsecured basis may well prefer to borrow on a secured basis to reduce interest cost. The Article combines theory and experience to show that those models do not reflect an economically rational debtor. A rational debtor that can borrow unsecured has an economic incentive not to prematurely encumber its assets because doing so gives away value in an amount, which the Article calls Theta, that exceeds any interest cost saving. Perhaps the most significant component of this value is the increased liquidity in times of financial trouble that secured credit affords. The Article also shows that this increased liquidity does not generally keep debtors alive that should be allowed to fail. Bankruptcy creates market imperfections that tend to make lenders reluctant to extend credit, even on a secured basis, to debtors that are likely to go bankrupt. Furthermore, these market imperfections discourage troubled debtors from incurring secured debt unless they can thereby avoid bankruptcy. Secured credit is therefore usually extended in these circumstances only where the liquidity would help the debtor regain viability. Therefore, unsecured creditors should want a debtor to have access to secured credit.
Michael St. James, Why Bad Things Happen in Large Chapter 11 Cases: Some Thoughts about Courting Failure:
The enactment of the Bankruptcy Code in 1979 made forum shopping possible: A company might choose among several different courts in which to file its Chapter 11 case. In COURTING FAILURE, Professor LoPucki argues that forum shopping has corrupted the bankruptcy courts, leading them to compete with each other for the largest bankruptcy cases, effectively by offering to rule in manners contrary to established law but favorable to the company or its major interest groups. LoPucki further argues that a statistical analysis of recidivism – companies that file for a second bankruptcy case within five years of successfully emerging from the first case – proves that the most competitive courts are doing the poorest jobs of reorganizing companies.
Allegations of judicial corruption prove a lightening rod for LoPucki’s critics. Salerno argues that, while there is forum shopping, it is an appropriate and legitimate aspect of the practice of bankruptcy law. Salerno is outraged by the allegations of corruption which he contends are factually wholly unsupported and unsupportable, and argues that LoPucki’s statistical methodology fails to address the important underlying issues because they are, by their nature, issues about which statistics are not available. Zywicki presents examples of good and bad forum shopping, and finds himself unable to determine how to characterize bankruptcy forum shopping. He challenges LoPucki’s contention that the judges are directly engaged in competition, noting that many of the cases attracted by the competitive courts would be unappealing to most judges, but agrees that a court’s expressed position on attorney’s fees has a significant affect on forum shopping.
The article concurs with the critics to the effect that evidence of corruption is weak and concludes that the characterization is unhelpful. Rather, the author argues that the source of the problem, as suggested by Professor Kuney, are the bankruptcy professionals. With floods of money running through the largest bankruptcy cases, Darwinism took hold: if professionals could identify courts that would adopt minority viewpoints favorable to critical constituencies and could forum-shop to those courts, the professionals would prosper and multiply. Conversely, if they were unable to deliver rulings on key issues that differed substantially from mainstream bankruptcy law by correctly selecting the best forum for the case, they would lose market share, replaced by professionals who could deliver the right rulings.
The author argues that, while some minority rulings have important policy consequences (i.e., willingness to issue critical vendor orders and third party releases), the most critical characteristic of a favored forum is a mindset: a willingness to treat bankruptcy proceedings as primarily multi-party private actions and to permit the parties to work out matters primarily privately and through private negotiation, encouraging and approving consensual resolutions among the litigants. The author argues that this deference is wrong-headed as a matter of bankruptcy policy: Virtually every order issued by a bankruptcy court affects the rights of third parties not before the court, and collectively dissidents and non-voting creditors often constitute one of the largest classes in any case. The legitimacy of the bankruptcy process – which binds dissidents and non-consenting parties to a forced adjustment of their legal rights – depends on the presence of a bankruptcy judge who is willing to exercise an independent adjudicative function. Independent adjudication renders a court less predictable and hence less desirable to forum shoppers, but without it the ability to bind the multitudes of creditors who do not affirmatively consent to the bankruptcy reorganization loses its legitimacy.
The author concludes that forum shopping has effectively ensured that the largest bankruptcy cases will be administered on the basis of minority views about bankruptcy law. There is a serious policy problem when mainstream bankruptcy law does not govern most of the large bankruptcy cases. Unfortunately, legislative repeal of the ability to forum shop seems unlikely, and no other mechanism seems available to correct this policy problem.
Bernard Trujillo, Patterns in a Complex System: An Empirical Study of Valuation in Business Bankruptcy Cases:
This Article applies complex systems research methods to explore the characteristics of the bankruptcy legal system. It presents the results of an empirical study of twenty years of bankruptcy court valuation doctrine in business cramdown cases. The data provide solid descriptions of how courts exercise their discretion in valuing firms and assets. This Article has two objectives: First, using scientific methodology, it explains the content of bankruptcy valuation doctrine. Second, the Article uses doctrine as a variable to explore the system dynamics that govern the processes of change over time. Significant findings include: (1) Courts tend to split the difference in valuations much less frequently than expected; (2) while early data show debtors’ and creditors’ valuation positions were close together, later data show the parties’ valuations moved further apart; (3) bankruptcy courts’ valuation approach is substantially influenced by whether the valuation includes a calculation for the time value of money; (4) there seems to be some geographic distribution of courts’ acceptance of valuation models, with courts in southern circuits more likely to accept soft valuation models, and nonsouthern circuit courts more likely to accept hard valuation models; and (5) the evidence offers preliminary support for the hypothesis that bankruptcy system content may self-organize according to some complex deterministic dynamics.
Catharine P. Wells, Who Owns the Local Church? A Pressing Issue for Dioceses in Bankruptcy:
The recent bankruptcies of Catholic Dioceses are unprecedented. For the first time, Bankruptcy Courts must deal with the difficult question of who owns the parish church. In this paper, I will explore two possible sources of confusion about this question. The first is the non- commercial, charitable nature of the Church. The second is its organizational complexity. Resolving the confusion requires a familiarity with various different sources of law including charities law, bankruptcy law, trust law, and Canon Law. In this paper I address this issue by: 1. discussing why the equities and policies that govern charitable bankruptcies are different from those that govern commercial bankruptcies; 2. laying out a road map for determining ownership issues that indicates what sub-questions must be answered and in what order; and 3. discussing the role that each of the different sources of law plays in answering these questions. My conclusion is that, in most circumstances, individual parishes do have a significant ownership stake in assets that are given or dedicated for their use.
Special thanks to the folks at ssrn.com, who suggested we let people know of the following policies and procedures in respect of downloading papers from SSRN:
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© Steve Jakubowski 2006