A Re-Examination of Near-Bankruptcy Investment Incentives

Abstract

The traditional justification for American corporate bankruptcy law that bankruptcy's stay of individual creditor collection keeps the wolves at bay. Without bankruptcy, the story goes, creditors might fail to negotiate for united action and in their attempts to claim limited assets dismember an insolvent but viable firm. Anticipation and conduct of this race, moreover, would require creditors to expend resources unnecessarily. Accordingly, the accepted wisdom that bankruptcy's collective proceeding protects the of debtor assets for the aggregate benefit of creditors and consequently saves creditors the expense of strategic positioning. An important component of this exegesis has been that bankruptcy law must protect firms from creditors not only after the onset of bankruptcy but also immediately before it. Thus, in many instances, a firm can recapture transfers to creditors if made while the firm insolvent and within the ninety-day period prior to the firm's bankruptcy. These recapturable transfers are called voidable preferences. In the leading volume on modern bankruptcy theory, Thomas Jackson explains that voidable preference law is essentially a transitional rule designed to prevent individual creditors from opting out of [bankruptcy's] collective proceeding once that event becomes likely. It part of the attempt to ameliorate the effects of a common pool problem that justifies a collective proceeding in the first place.1 On close analysis, however, preference law may not serve the purpose given in this standard justification. Preference law as guardian of the common pool a notion based on a view of the firm as a static pool of assets that exists independently of the