Corporate reorganization rules is to be judged and the fundamental problem of valuation: THE OPTIONS ALTERNATIVE TO EXISTING RULES

Corporate reorganization rules is to be judged and the fundamental problem of valuation: THE OPTIONS ALTERNATIVE TO EXISTING RULESAnother alternative to the existing bargaining approach is the “options approach.” This approach was put forward in Bebchuk and subsequently also advocated by Aghion, Hart and Moore and Hart.

Like the auctions approach, the options approach seeks to eliminate bargaining -and with it the costs and deviations from contractual priority that accompany it. Furthermore, the options approach seeks to do so in a way that would ensure that no participants would get less than the value of their entitlement. Under the approach, all the participants in a reorganization would receive certain options with respect to the new tickets of the reorganized value. The division of value would result from the participants’ own decisions concerning the exercise of the options given to them. And the options would be designed so that, whatever the reorganization value, no participants would ever be able to complain that they would end up with less than the value to which they are entitled.

To explain how the options scheme works, consider the following very simple example. Suppose that RC is a company in reorganization that has two classes of participants: 100 debtholders each being owed $1, and 100 shareholders each owning one unit of equity. And suppose that the reorganized company is going to have 100 units of securities; thus, the problem for the reorganization process is how to divide the 100 units of reorganization tickets among the participants.

Let V denote the value of each unit of the reorganized company. Using this notation, each debtholder in our example is entided to V if V < 1 and to 1 if V >_1, and each equityholder is entitled to 0 if V< 1 and to V-l if V> 1. If V were verifiable, we would have no problem in dividing the units of RC so as to give all participants their entitlement, but V is not verifiable and this is where the option scheme comes in.