Reorganization Law and Dilution Threats in Different Financial Systems

U. Hege, P. Mella-Barral

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Abstract

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
PublisherFinance
Number of pages29
Volume2000-50
Publication statusPublished - 2000

Publication series

NameCentER Discussion Paper
Volume2000-50

Fingerprint

financial system
reorganization
threat
Law
indebtedness
market
bank
welfare
firm
national debt
creditor
bankruptcy
credit
legislation
determinants

Keywords

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

Cite this

Hege, U., & Mella-Barral, P. (2000). Reorganization Law and Dilution Threats in Different Financial Systems. (CentER Discussion Paper; Vol. 2000-50). Tilburg: Finance.
Hege, U. ; Mella-Barral, P. / Reorganization Law and Dilution Threats in Different Financial Systems. Tilburg : Finance, 2000. (CentER Discussion Paper).
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Hege, U & Mella-Barral, P 2000 'Reorganization Law and Dilution Threats in Different Financial Systems' CentER Discussion Paper, vol. 2000-50, Finance, Tilburg.

Reorganization Law and Dilution Threats in Different Financial Systems. / Hege, U.; Mella-Barral, P.

Tilburg : Finance, 2000. (CentER Discussion Paper; Vol. 2000-50).

Research output: Working paperDiscussion paperOther research output

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T1 - Reorganization Law and Dilution Threats in Different Financial Systems

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N2 - 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.

AB - 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.

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KW - exit consents

KW - hold-in effect

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Hege U, Mella-Barral P. Reorganization Law and Dilution Threats in Different Financial Systems. Tilburg: Finance. 2000. (CentER Discussion Paper).