Coase-Sandor Working Paper Series in Law and Economics

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Law & Economics Working Papers


Bankruptcy rules often enable equityholders to obtain value even though debtholders are not paid in full. This paper addresses the ex ante effects of violations of absolute priority. These violations should influence decisions concerning project choice and human capital investment that determine the extent to which a firm?s managers have an advantage over others in operating the firm?s assets. In an absolute priority regime, managers will ?entrench? themselves by overinvestment in assets that require their unique skills. Managers will also underinvest in firm-specific human capital. Allowing ex post violations of absolute priority decreases the severity of these two problems.



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