Bankruptcy scholars have long organized their field around a stylized story, a paradigm, of lender control. When lenders extend credit, the story goes, they insist on the borrower agreeing to strict covenants and granting blanket liens on its assets; then, if the borrower later encounters financial distress, they use their bargained-for rights as prods to steer the company toward a resolution favorable to themselves, whether or not that resolution is value maximizing for the investors as a group. As fruitful as the lender-control heuristic has been, however, it no longer corresponds to reality.
Vincent S.J. Buccola
This Article was substantially written while Mah and Zhang were undergraduates, and it reflects neither the opinions of nor nonpublic information about their employers. The authors thank Ken Ayotte, Allison Buccola, Saul Levmore, Josh Macey, Adriana Robertson, Mike Simkovic, David Skeel, Matt Turk, and participants at a Wharton faculty workshop for criticism of defunct drafts.
A basic assumption in the standard paradigm of corporate finance is that a company’s investors want the company to succeed. To be sure, investors of different classes—stockholders and bondholders, for example—bear risk and reward unequally.
Thanks to Douglas Baird, Allison Buccola, Steve Buccola, Laura Coordes, Brian Hathaway, Rich Hynes, Juliet Moringiello, Eric Rasmusen, David Schleicher, and David Skeel for extensive comments on earlier drafts; and to Joe Gyourko and Bob Inman for generative conversations. Thanks also to participants in workshops at Wharton and the Indiana University Kelley School of Business. Dorinda and Mark Winkelman provided valuable research support.
Cities and towns across the country face debt burdens of a magnitude not seen since the Great Depression. Four of the five largest municipal bankruptcies in history have been filed in the last decade, and more are bound to come.
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