Corporate reorganization rules is to be judged and the fundamental problem of valuation: CONCLUDING NOTE ON THE DIVISION OF VALUE

There is another line of work that in closing would be worth noting. This work has sought to analyze the effects that the distribution of value in Chapter 11 has on ex ante decisions.
Some of this work has shown that a sequential distribution of value — that is, a distribution in which equityholders receive no value if the value of debt exceeds the value of the assets — might have some negative ex ante effects. For example, such sequential distribution might lead to excessive risk-taking in financial distress prior to filing for bankruptcy (see Gertner and Scharfstein ); discourage the initiation of bankruptcy proceedings when such initiation is desirable (see Baird; and lead to excessive entrenchment of managers-owners (see Bebchuk and Picker and Berkovitz, Israel, and Zender ). Thus, the question arises whether this work implies that the prevailing bargaining-based approach, which enables equityholders to extract some value even when debtholders are not paid in full, might be desirable after all. Monotheistic Concept

Drawing such a conclusion from the above work is not warranted. To begin, while the work on ex ante effects has shown that sequential division might have some negative ex ante effects, it also has found that such division might have some beneficial ex ante effects. For example, deviations from sequential distribution have been shown to exacerbate the moral hazard problem between equity and debt prior to the onset of financial distress (see Bebchuk ). Overall, our present state of knowledge does not enable us to conclude whether and when the optimal distribution of bankruptcy value is not sequential.
More importantly, under an auctions regime or an options regime, when a nonsequential division of value in the event of insolvency would be ex ante desirable, participants would be able to prescribe this division in their ex ante contract.
Accordingly, having a bargaining regime is not required to getting the division of value that would be optimal ex ante. Both the auctions approach and the options approach would seek to implement whatever distribution was agreed upon ex ante. And, in cases in which the participants would agree ex ante on a non-sequential distribution, it would be possible to implement such a distribution both under the auctions approach and under the options approach (see Bebchuk for a description of how the options approach can be adjusted to implement non-sequential distributions). Thus, whatever is the desirable division of value in insolvency, seeking to implement it through the costly and unpredictable process of bargaining is likely to be inferior, for the reasons discussed in this essay, to doing so through the auctions approach or the auctions approach.