Abstract

The US bankruptcy code provides enhanced priority and security features to debtor-in-possession (DIP) loans which can be obtained from a lender with whom the borrower may have no past lending relationship. The enhanced priority of DIP financing, and the choice of a DIP lender, significantly impact the investment decisions made by the firm. We show DIP loans from an existing lender leads to a higher level of investment. We also show that a higher priority of DIP financing also leads to higher investment by the firm. A bankruptcy judge should take these incentives into account when approving the DIP loan.

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