Reorganization Law and Dilution Threats in Different Financial Systems

U. Hege, P. Mella-Barral

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In a market-based financial system, credit is held by dispersed creditors, and out-of-court renegotiation of debt is more likely to fail because of hold-out problems; in a bank-based system, out-of-court renegotiation stands good chances to succeed. Since out-of-court renegotiation is a substitute for court-supervised reorganization, the design of a reorganization law cannot abstract from the financial system. Chapter 11-style renegotiation is shown to benefit public debt firms and to be harmful for private debt firms; the overall effect depends on the financial system, but is likely to be positive only in a market-based system. The case for a reorganization law is weakened if dilution threats like exit consents are taken into account: such a law is then in most cases undesirable. Legislation, however, which jointly introduces a reorganization law while facilitating the use of dilution threats will improve welfare in a market-based system, but reduce welfare in a bank-based system. Thus, the paper indentifies a new determinant in the debate over optimal bankruptcy codes, which is how easily dilution threats can be deployed.
Original languageEnglish
Place of PublicationTilburg
Number of pages29
Publication statusPublished - 2000

Publication series

NameCentER Discussion Paper


  • Workouts
  • reorganization law
  • Chapter 11
  • financial systems
  • dilution threats
  • exit consents
  • hold-in effect


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