Strange Visions in a Strange World: A Reply to Professors Bradley and Rosenzweig
Much about chapter 11 is in need of improvement. But, as is so often the case, the resonant themes are not the right ones. All three legs of Bradley and Rosenzweig’s argument for repeal are seriously flawed. The heart of their empirical argument is their claim to have shown that financially stronger companies reorganizing under chapter 11 have been paying less to both their creditors and their shareholders than did weaker companies reorganizing under prior law. In Part I below, I present several more plausible explanations for the stock and bond price phenomena they observed. In all likelihood, their data reflect not a difference in the efficiency of the Act and Code regimes, as they claim, but merely the arrival of the junk bond era. Chapter 11 is processing more highly leveraged companies.
Bradley and Rosenzweig’s provocative assertion that chapter 11 shields managers from creditors while they expropriate for themselves the wealth of both bondholders and stockholders in no way follows from their empirical findings, nor is it true. In Part II, I present empirical evidence from several studies to show that during the reorganization of large, publicly held companies, managers are rarely the powerful actors that Bradley and Rosenzweig make them out to be. Reorganization managers are more likely to serve creditor interests directly or pursue some more complex course calculated to keep everybody happy and thereby preserve their jobs and reputations.
The third leg of Bradley and Rosenzweig’s argument for repeal of chapter 11 is their assertion that, in its absence, the conflicts between failing companies and their creditors could be regulated through contracts and markets. In Part III, I argue that their analysis depends so heavily on the twin assumptions of perfect capital markets and zero transaction costs that it is not helpful in evaluating the usefulness of chapter 11. Their strange visions of debtor-creditor relations after repeal of chapter 11 are the unique product of the strange world in which they conduct their analyses. In Part IV, I generalize from the critique of Bradley and Rosenzweig’s proposal to a more general critique of the use of perfect market zero transaction cost models in the evaluation of procedures for bankruptcy reorganization and perhaps other legal regimes as well.