Game-Theoretic Bankruptcy Valuation

The rules of bankruptcy reorganization in the United States permit a debtor to retain a secured claim’s collateral in exchange for judicially approved compensation even over the objection of the secured creditor. An alternative would grant a secured creditor the right to recover its collateral unless satisfied with the compensation, a right often implicit in modern bankruptcy practice despite the formal rules. Either debtor or secured creditor domination of the bankruptcy process may yield inefficient continuation decisions, violations of absolute priority, and high transactions cost. As a remedy to these pitfalls, a mechanism that would mediate between debtor and creditor control and could harness the parties’ information about collateral value is proposed here: junior interests would, on behalf of the debtor, propose a reorganization plan that could include a take-it-or-leave-it offer for collateral with assured liquidation of the collateral being the consequence if the secured creditor rejected the plan.