Corporate reorganization rules is to be judged and the fundamental problem of valuation: THE EFFECT OF EXISTING RULES ON DIVISION OF VALUE

Corporate reorganization rules is to be judged and the fundamental problem of valuation: THE EFFECT OF EXISTING RULES ON DIVISION OF VALUEThe existing bargaining-based approach leads to a division of value that often deviates from the division that is prescribed by the participants’ contractual rights (or, in the case of involuntary tort creditors, from the division that is prescribed by the relevant legal rules). What each class gets under the existing process depends not only on the value to which it is entitled but also on various factors that affect the strength of its bargaining position under the existing rules. In particular, because the equityholders can often block or at least delay the approval of a plan, they will have some bargaining power even in those cases in which the value of debt exceeds the total reorganization value. The deviations from contractual priority under the existing rules are quite well documented by empirical work – work indicating that, even when creditors are not paid in full, equityholders are often able to extract significant value (see, e.g, Eberhart, Moore and Roenfeldt, Franks and Torous, and Weiss.
Bebchuk and Chang develop a model of the bargaining under the existing rules that identifies three reasons as to why equityholders might be able to extract value even when creditors are not paid in foil. (The second of the reasons listed below is also suggested by the models of Baird and Picker and Bergman and Callen ). First, if equityholders delay agreement over a plan, there may be a favorable resolution of uncertainty that would cause the value of the firm to exceed the value of its debt.