Corporate and Personal Bankruptcy Lawmiwhite/annurev-lawsocsci-White.pdf · LS07CH08-White ARI 1 October 2011 17:47 Corporate and Personal Bankruptcy Law Michelle J. White1,2 1Department

LS07CH08-White ARI 1 October 2011 17:47

Corporate and PersonalBankruptcy LawMichelle J. White1,2

1Department of Economics, University of California, San Diego, La Jolla, California 92093;email: [email protected] Kong Graduate School of Business, and Research Associate, National Bureau ofEconomic Research, Cambridge, Massachusetts 02138

Annu. Rev. Law Soc. Sci. 2011. 7:139–64

The Annual Review of Law and Social Science isonline at lawsocsci.annualreviews.org

This article’s doi:10.1146/annurev-lawsocsci-102510-105401

Copyright c© 2011 by Annual Reviews.All rights reserved

1550-3585/11/1201-0139$20.00

Keywords

reorganization, liquidation, priority, absolute priority rule, default,exemptions, filtering failure, workouts, fresh start, foreclosure

Abstract

Bankruptcy is the legal process by which the debts of firms, individ-uals, and occasionally governments in financial distress are resolved.Bankruptcy law always includes three components. First, it providesa collective framework for simultaneously resolving all debts of thebankrupt entity, regardless of when they are due. Second, it providesrules for determining how the assets and earnings used to repay aredivided among creditors. Third, bankruptcy law specifies punishmentsintended to discourage debtors from defaulting on their debts and fil-ing for bankruptcy. This review discusses and evaluates bankruptcy lawby examining whether and when the law encourages debtors and cred-itors to behave in economically efficient ways. It also considers howbankruptcy law might be changed to improve economic efficiency. Thereview shows that there are multiple economic objectives of bankruptcylaw because the law has very diverse effects. Some of these objectivesdiffer for individuals versus corporations in bankruptcy.

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INTRODUCTION

Bankruptcy is the legal process by which thedebts of firms, individuals, and occasionallygovernments in financial distress are resolved.Debtors file for bankruptcy because they can-not pay debts as they come due and/or becausetheir liabilities exceed their assets.

Bankruptcy law always includes three com-ponents. First, it provides a collective frame-work for simultaneously resolving all debts ofthe bankrupt entity, regardless of when thedebts come due. Bankrupts may be required touse some or all of their assets to repay theirdebts: Bankruptcy law includes rules determin-ing which assets must be used to repay debtsversus which assets bankrupts are allowed tokeep (if any). Bankrupts may also be requiredto use some of their future earnings to re-pay debts, and bankruptcy law provides simi-lar rules determining how much of their futureearnings must be used to repay debts. Theserules differ depending on whether bankruptsare corporations, individuals, or governments.Second, bankruptcy law provides rules for de-termining how the assets and earnings used torepay debts are divided among creditors. Thispart of bankruptcy law also includes rules thatlimit creditors’ rights to grab assets and keepthose assets out of the collective debt resolu-tion procedure. Thus bankruptcy law deter-mines both the size of the pie in bankruptcy,i.e., the total amount paid to creditors, andthe division of the pie among individualcreditors.

Third, bankruptcy law specifies how debtorsare punished for filing for bankruptcy. Inthe United States, the main punishments forbankruptcy are making filers’ names public andallowing the bankruptcy filing to remain ontheir credit records for 10 years. These pun-ishments stigmatize bankruptcy filers and harmthem financially because they face greater diffi-culty postbankruptcy in obtaining loans, rent-ing apartments, and sometimes obtaining jobs.In the United Kingdom, punishments includebarring bankruptcy filers from managing firmsor holding certain public offices for a period

of time after filing.1 Another part of the pun-ishment for bankruptcy is whether and whenfilers’ liability to repay debts is discharged. Inthe United States, most bankruptcy filers re-ceive a quick discharge from debt, but in Franceand Germany, discharges are issued only af-ter debtors use part of their earnings for 5 to10 years to repay debts, and bankruptcy judgescan deny the discharge if they feel that debtorsdid not try hard enough to repay debts. In othercountries, debt discharge occurs only when thedebtor dies. For corporations in bankruptcy,debt is discharged quickly, but the corporationitself ceases to exist.

Bankruptcy procedures may involve ei-ther liquidation or reorganization of thebankrupt entity. When corporations liquidatein bankruptcy, all of their assets are sold andthe proceeds are used to repay creditors. Assetsmay be sold piecemeal or as a going concernif the corporation is still operating when itfiles for bankruptcy. The size of the pie inbankruptcy liquidation is all of the corpora-tion’s assets. When corporations reorganizein bankruptcy, they keep some or all of theirassets, continue to operate, and follow a plan touse part of their future earnings to repay debt.In this situation, the pie includes only part ofthe corporation’s assets, but it also includespart of the corporation’s future earnings. Forindividuals, bankruptcy never involves com-plete liquidation. Individual bankrupts may berequired to give up some of their assets; these

1There are other punishments for debtors who default butdo not file for bankruptcy, including credit collectors call-ing them, suing them, and garnishing their wages (see belowfor further discussion). Past punishments for default werefar more severe and included the death penalty, exile, sellingdebtors into slavery, and putting them in debtors’ prisons.Early bankruptcy laws also specified severe punishments forfiling, including debtor’s prison and the death penalty forfilers who concealed assets. Debts were discharged only ifcreditors consented. See Efrat (2006) for multicountry infor-mation on punishments for default and bankruptcy. Sandage(2005), Balleisen (2001), and Mann (2002) discuss attitudestoward debt and default in the United States and the adoptionof U.S. bankruptcy laws—there were several—in the nine-teenth century. Skeel (2001) gives a history of U.S. personaland corporate bankruptcy law during the twentieth century.

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are liquidated and the proceeds are used torepay creditors. But individuals’ most valuableasset is usually their human capital—theireducation and training—and the only way toliquidate human capital is to sell individualsinto slavery. Because slavery is no longerallowed, bankrupt individuals always keep theirhuman capital and the right to decide whetherand how to use it. Thus bankrupt individualsalways keep some of their assets. However, likecorporations that reorganize, bankrupt individ-uals may be obliged to use some of the futureearnings that their human capital produces torepay creditors, usually for a fixed number ofyears. This means that bankruptcy proceduresfor individuals are always reorganizations, andthe size of the pie used to repay creditors isless than the value of bankrupt individuals’assets.

This review discusses and evaluatesbankruptcy law by examining whether andwhen the law encourages debtors and creditorsto behave in economically efficient ways. Italso considers how bankruptcy law might bechanged to improve economic efficiency. Thediscussion abstracts from the details of U.S. andother countries’ bankruptcy laws in order tofocus on common features of bankruptcy law,and it also attempts to avoid use of legal terms.This review shows that bankruptcy law has avariety of economic objectives, some of whichdiffer for individuals versus corporations. Thevariety of economic objectives results from thefact that bankruptcy law has widespread effects:causing responses that change the supply anddemand for many types of credit; which finan-cially distressed firms shut down versus whichcontinue to operate; corporate managers’ in-centives to work hard, invest, and take risks; andindividual debtors’ incentives to work hard, be-come entrepreneurs, take risks, buy insurance,and even get divorced. Bankruptcy also affectscompetitors of financially distressed firms andthe welfare of debtors’ family members andneighbors.

Section I discusses research on corporatebankruptcy and Section II discusses research

on personal and small business bankruptcy.2

Corporate bankruptcy refers to the bankruptcyof large- and medium-sized firms, which I as-sume are organized as corporations. Personalbankruptcy refers to the bankruptcies of bothindividual debtors and small businesses. Smallbusiness bankruptcy is treated as part of per-sonal bankruptcy because small businesses areowned by individuals or partners who are legallyresponsible for their business debts. Whenbusinesses fail, owners often file for personalbankruptcy in order to have their business debtsdischarged. Even when small businesses are in-corporated, owners often guarantee the debtsof their businesses, so personal bankruptcy lawapplies.

I. CORPORATE BANKRUPTCY

Bankruptcy law affects the economic efficiencyof corporate behavior, both when corporationsare in financial distress and when they are fi-nancially healthy.

Effects of Priority Rules in Bankruptcyon Corporate Behavior

Priority rules are rules for dividing repaymentin bankruptcy among creditors and sharehold-ers of a corporation. An important priority ruleis the absolute priority rule (APR), which re-quires that unsecured creditors be repaid in fullbefore shareholders receive anything. Whenthere are multiple creditors, priority amongthem is determined by whether creditors havea secured interest in a particular asset ownedby the corporation or by whether creditorshave made agreements with the corporationthat specify a priority ordering. Suppose acorporation has creditors A and B and A’sloan was made before B’s. If A’s contract with

2Owing to lack of space, governmental (“sovereign”)bankruptcy is ignored. Much of the discussion concernsthe possibility of establishing a bankruptcy procedure forsovereign default that would have the three characteristicsdiscussed above (see McConnell & Picker 1993, White 2002,and Bolton & Jeanne 2007).

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the corporation specifies that its claim willtake priority in bankruptcy over the claimsof later creditors, then A’s claim is paid infull in bankruptcy before B receives anything.Alternatively, suppose A has a secured claimon the corporation’s computer. Then A cantake the computer in bankruptcy, which meansthat A’s claim is paid up to the value of thecomputer before B receives anything. If thereis no contractual agreement, then A and Bhave equal priority in bankruptcy and the APRrequires that they be paid the same proportionof their claims. The legal justification for theAPR is that it treats creditors in bankruptcyaccording to the contracts they made withthe corporation outside of bankruptcy. “Devi-ations from the APR” refer to paying positiveamounts to lower-priority creditors or share-holders in bankruptcy when higher-prioritycreditors receive less than full repayment.

Priority rules affect both the size and the di-vision of the pie. Changes in priority amongcreditors have no effect on the size of the pie,but they do change the division of the pie.When creditors receive less than full repaymentand shareholders receive positive payment, thendeviations from the APR occur and they reducethe size of the pie.

Priority rules affect the economic efficiencyof corporate behavior. Consider first howthey affect whether corporate managers makeeconomically efficient bankruptcy decisions.Assume that the corporation is in financial dis-tress and managers—representing the interestsof shareholders—must choose between filingfor bankruptcy or continuing to operate outsideof bankruptcy. The only bankruptcy procedureis liquidation. Corporations in financial distressmay be either economically efficient or eco-nomically inefficient. They are economically ef-ficient (despite being in financial distress) whenthe most valuable use of their assets is the cur-rent use, and they are economically inefficientwhen their assets are more valuable in someother use. When corporations are economicallyinefficient, the best outcome is liquidation be-cause liquidation frees the corporation’s assetsto move to more valuable uses. Conversely,

when corporations are economically efficient,the best outcome is for them to continue oper-ating outside of bankruptcy because this keepsthe assets in their current use. Filtering failureoccurs when corporations that should liquidatecontinue to operate or vice versa. Assume thatmanagers and creditors are fully informedabout the value of the corporation’s assets intheir current use and also in alternate uses.

Suppose the corporation owes a debt of DA

dollars to creditor A, which is due in period 1,and a debt of DB to creditor B, which is due inperiod 2. Total debt D equals DA + DB . Thecorporation has no cash on hand. The liquida-tion value of the assets in period 1 is L, andbecause L < D, the corporation is insolvent.Managers can either file for bankruptcy and liq-uidate in period 1 or continue to operate thecorporation outside of bankruptcy until period2. In the latter case, assume that the corpora-tion will earn P2 with certainty in period 2, butthe liquidation value of its assets falls to zero. Ig-noring the time value of money, continuation inperiod 1 is economically efficient if P2 > L andliquidation is economically efficient otherwise.

To avoid bankruptcy in period 1, managersmust repay creditor A, and the only way they cando so is to obtain a new loan from creditor C forthe amount DC = DA. The new loan will be duein period 2. If managers obtain the new loan, thecorporation will continue to operate until pe-riod 2, when it will shut down and distribute itsassets according to the APR. Depending on theterms of creditor B’s and C’s contracts with thecorporation, either creditor could take priorityunder the APR, or they could have equal prior-ity. Assume first that creditor B takes priority,i.e., priority is in chronological order.

In period 1, creditor C and managers areassumed to make the corporation’s bankruptcydecision jointly, so that creditor C makes theloan if it and shareholders jointly gain whenthe corporation continues to operate. If liqui-dation occurs in period 1, then all of the cor-poration’s assets go to pay creditors, and share-holders receive nothing. If creditor C makes theloan and the corporation continues to operate,then creditor C and shareholders together will

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receive max[P2 − DB ,0]−DC in period 2. Forcreditor C and shareholders to prefer continu-ation, this expression must be positive, whichimplies that P2 > DB + DC = D. But be-cause D > L, this also means that P2 > L.Thus creditor C and shareholders choose con-tinuation only when it is economically efficient.But they may choose liquidation when contin-uation is more efficient: This outcome occursif creditor C and managers choose liquidationbecause max[P2 − DB ,0]−DC is negative, or ifP2 < D, but continuation is economically effi-cient because L < P2. Thus some efficient cor-porations liquidate in bankruptcy—an exampleof filtering failure. This result occurs becausechoosing continuation increases the amount re-paid to creditor B, but managers and creditorC ignore this gain because they do not shareit. Overall, when priority among creditors is inchronological order, too much liquidation oc-curs in bankruptcy.3

Now suppose priority among creditors Band C is reversed, so that it is in reverse chrono-logical order. Then creditor C is more likely tolend, and therefore financially distressed cor-porations are more likely to continue ratherthan liquidating. But the condition for contin-uation to be economically efficient remains thesame. Thus when priority is in reverse chrono-logical order, fewer economically efficient cor-porations liquidate in bankruptcy. But nowthe opposite type of filtering failure may oc-cur because more inefficient corporations avoidbankruptcy and continue operating.

These examples show that priority rules af-fect whether filtering failure occurs and may re-sult in either too much liquidation or too muchcontinuation. Too much liquidation is likelywhen priority among lenders is in chronologicalorder, whereas too much continuation is likelywhen priority is in reverse chronological order.The latter result implies that lenders have anincentive to make loans to financially distressed

3This result is an application in bankruptcy of Myers’s (1977)“debt overhang” problem. For discussion of the effects ofpriority rules in bankruptcy, see Bulow & Shoven (1978),White (1980), and Schwartz (1981).

corporations if by doing so they can jump overearlier lenders in the priority ordering (seeBebchuck & Fried 1996 and Stulz & Johnson1985 for discussion).

Now suppose corporations’ future earningsare uncertain rather than certain. Suppose thecorporation’s earnings, if it continues to op-erate until period 2, are P2 + G or P2 − G,each with 0.5 probability. Suppose creditor Bhas priority over creditor C, and assume thatearnings in the good outcome are sufficient torepay creditor B in full, whereas earnings in thebad outcome are not. If creditor C lends andthe corporation continues to operate, creditorC and shareholders’ joint expected return in pe-riod 2 is .5(P2 + G − DB ) − DC . Creditor Clends and the corporation continues to operateif this expression is positive, but continuationis economically efficient if P2 ≥ L. This meansthat as the corporation’s earnings become moreuncertain (G rises), inefficient continuation ismore likely to occur. This is because creditorC and shareholders get the additional earningsin the good outcome, but creditor B bears theadditional losses in the bad outcome. This re-sult illustrates the fact that corporate managersand shareholders often prefer risky over safe in-vestments even when risky projects offer lowerexpected returns because shareholders gain dis-proportionately from risky projects if they suc-ceed. This effect applies both to corporations’bankruptcy decisions and to their investmentdecisions generally (see Stiglitz 1972 and Jensen& Meckling 1976 for discussion in the non-bankruptcy context).

Now suppose reorganization is an alter-native bankruptcy procedure.4 Managers ofcorporations in financial distress are now as-sumed to choose among continuing outsideof bankruptcy, liquidating in bankruptcy, and

4In the United States, managers of corporations inbankruptcy generally have the right to choose between reor-ganization or liquidation, but in other countries the decisionis usually made by a bankruptcy court appointee who alsoreplaces the manager. See Franks et al. (1996), White (1996),Berkovitch & Israel (1998), and Franks & Sussman (2005) forcomparison of bankruptcy law across countries.


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reorganizing in bankruptcy. When corpora-tions reorganize in bankruptcy, managers areassumed to remain in control at least temporar-ily, and unsecured debt payments are suspendeduntil a reorganization plan is adopted. Thistemporary debt holiday improves corporations’cash flow and helps them to continue operating.Assume that the reorganization plan requirescorporations to pay all creditors a fraction r oftheir claims in period 2. Also assume that thecorporation has only one creditor, creditor E,whose claim of DE is due in period 1. Becauseof the debt holiday, the corporation no longerneeds a new loan in period 1 to continue oper-ating. If it reorganizes, assume that its earningswill still be P2 ± G in period 2, each with 50%probability, and its assets will still be worthlessat the end of period 2.

Introducing reorganization allows us to ex-amine the effects of deviations from the APR.Deviations from the APR often occur whenU.S. corporations reorganize in bankruptcy be-cause reorganization plans must be approvedby vote of shareholders as well as creditors.Shareholders must therefore receive some pay-ment or else they would vote against the plan.5

Suppose shareholders are promised a paymentequal to a fraction α of creditors’ claims, or αDE .If α is positive, then there are deviations fromthe APR; higher values of α imply that the pay-off rate r to creditors is lower.

If the corporation reorganizes, shareholders’expected return becomes .5(P2 + G − r DE ) +.5(αDE ), where P + G + rDE and αDE rep-resent the payments that shareholders receivein the good and bad outcomes, respectively.Deviations from the APR raise α and lower r, sothat they both increase shareholders’ expectedreturn and reduce their risk. Because share-holders receive nothing if the firm liquidates inperiod 1, managers prefer reorganization overliquidation in bankruptcy as long as this expres-

5Deviations from the APR can alternately be seen as pay-ments by creditors to prevent shareholders from delayingthe reorganization process. See Bebchuk & Chang (1992)for a model and Bebchuk (1998) for discussion of the U.S.reorganization process generally.

sion is positive, and they prefer reorganizationover continuing to operate the firm outside ofbankruptcy because .5(P2 +G−r DE )+.5(αDE )exceeds .5(P2 + G − DE ). But reorganizingis economically efficient only if P2 > L, andthis condition is unaffected by introducingreorganization. Thus introducing reorgani-zation in bankruptcy causes more filteringfailure because more corporations continue tooperate, some of which should liquidate.

Introducing reorganization in bankruptcyalso affects managers’ incentive to choose safeversus risky investment projects. When cor-porations are in financial distress, suppose theprobability of the bad outcome increases in ourexample from 0.5 to 0.9. Shareholders’ returnthus comes mainly from their payoff of αDE inthe bad outcome. When deviations from theAPR are zero, then αDE = 0 and shareholdersget nothing in the bad outcome. This meansthat managers have an incentive to invest invery risky projects (those with high G), becauseshareholders receive a payoff only when therisky investment project is chosen, it succeeds,and its return .5(P2+G−DE ) is large enough tosave the corporation. Managers therefore pre-fer risky projects even when they have low ex-pected returns and are economically inefficient.But deviations from the APR give shareholdersa positive return even when the bad outcomeoccurs and the firm fails, so that managers’ in-centive to select excessively risky investmentprojects is smaller. Thus deviations from theAPR improve efficiency when corporations arein financial distress by reducing managers’ in-centive to choose extremely risky investments.6

This discussion shows that introducingreorganization as an alternative bankruptcyprocedure increases filtering failure by savingmore financially distressed corporations whenthey should be shut down.7 But the option of

6But deviations from the APR have the opposite effect onmanagers’ incentives when corporations are not in financialdistress. See Bebchuk (2002) and Cornelli & Felli (1997) fordiscussions.7See Weiss & Wruck (1998) for a discussion of Eastern Air-lines as an example of an inefficient corporation that was saved

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reorganizing reduces managers’ incentivesto invest in excessively risky investmentprojects when their corporations are financiallydistressed, so that reorganization has mixedeffects on economic efficiency. The discussionalso suggests that none of the commonlyused priority rules in bankruptcy always givecorporate managers an incentive to make bothefficient bankruptcy decisions and efficientinvestment choices.

Other Effects of Bankruptcy Law:Strategic Default andManagerial Effort

Now turn to the effect of bankruptcy law onwhether corporations default on debt obliga-tions when they are not in financial distress—called strategic default. Suppose there are twotypes of corporations, solvent and insolvent. As-sume that the most efficient outcome for bothtypes of corporations is to continue operating.Managers of both types of corporations decidewhether to repay in full or default. If they de-fault, they offer to pay creditors a fraction oftheir claims, and creditors must decide whetherto accept or reject. If creditors accept, thenthe new debt agreement goes into effect—it iscalled a nonbankruptcy workout. If creditors re-ject, then managers of insolvent corporationsfile for bankruptcy, whereas managers of sol-vent corporations remain out of bankruptcy andrepay in full. Because bankruptcy is assumedto be costly, the most efficient outcome is forinsolvent corporations to use nonbankruptcyworkouts to resolve their financial distress. Sol-vent corporations should repay their loans infull because the supply of credit is larger whenfewer defaults occur.

Suppose managers of insolvent corpora-tions always default and propose workouts,whereas managers of solvent corporations mayeither default or repay in full. Creditors would

in bankruptcy reorganization when it should have liquidated.See Lang & Stulz (1992) and Borenstein & Rose (2003) fordiscussions of the effect of airline bankruptcies on competi-tion in the industry.

like to accept all workout plans offered byinsolvent corporations and reject all workoutplans offered by solvent corporations. If theycould do so, then insolvent corporations wouldalways use nonbankruptcy workouts, whereassolvent corporations would never default. Thisoutcome would be efficient because no strategicdefault and no costly bankruptcy would occur.But models of strategic default assume thatthere is asymmetric information about corpo-rations’ financial status, meaning that managersknow whether their corporations are solvent,but creditors do not. Under this assumption,creditors cannot identify individual corpora-tions’ types and they must respond in the sameway to all workout offers. Creditors have anincentive to accept workout proposals becausebankruptcy costs are assumed to be high, andtherefore creditors receive little if corporationsfile for bankruptcy. But they also have anincentive to reject workout proposals in orderto discourage strategic default. In equilibrium,creditors reject some or all workout proposals,and this means that at least some insolvent cor-porations end up in bankruptcy. Asymmetricinformation thus implies that there will alwaysbe either some strategic default or some costlybankruptcy, or a combination of both (seeSchwartz 1993, Gertner & Scharfstein 1991,and White 1994 for discussions).

Financial contracting models extend thisanalysis earlier in time to when creditors andmanagers first negotiate the terms of theirloans (see Hart & Moore 1998 and Bolton& Scharfstein 1996b for discussions). Oftenthese models assume that corporations are justbeing established, with entrepreneurs that haveinvestment projects but no cash to finance themand creditors/investors that have cash but noinvestment projects. Suppose a creditor lendsD dollars to an entrepreneur in period 0. Inperiod 1, the project either succeeds or fails. Inperiod 2, it either succeeds and earns a returnof R2 > D, or it fails and earns zero. In period3, it earns R3 regardless. Also assume that theproject’s assets have positive liquidation valueL in period 2, but they are worthless in period3. Since R3 > L, it is always efficient for the


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project to continue until period 3, which meansthat bankruptcies in period 2 are inefficient.

Information is now assumed to be incom-plete, but symmetric. All parties are assumedto observe the corporation’s return eachperiod, but creditors and entrepreneurs areassumed unable to make a contract based onthese returns because they are not verifiablein court. But creditors and entrepreneurs canmake enforceable contracts specifying thatcreditors must receive fixed dollar payments atparticular times and that they have the right toliquidate the corporation otherwise. Supposethe contract specifies that the entrepreneurwill pay creditors D′ in period 2; otherwise,creditors have the right to liquidate the cor-poration and collect L. Under this contract,entrepreneurs never default strategically; theyrepay D′ in period 2 if the project succeedsand default if it fails. Entrepreneurs repay inperiod 2 whenever they can because they gainfrom retaining control of the corporation andcollecting R3 in period 3. The contract doesnot call for entrepreneurs to pay anything toinvestors in period 3—any obligation by en-trepreneurs to pay in period 3 is unenforceablebecause the corporation has zero liquidationvalue and therefore investors cannot punishentrepreneurs for defaulting.

This type of contract eliminates strategicdefault but causes some bankruptcies to occurin period 2. This is because creditors liquidatecorporations that default in period 2, eventhough liquidation is inefficient. Otherwise,managers would have an incentive to strate-gically default. Investors alternatively mightplay mixed strategies and only sometimes liq-uidate corporations that default—this reducesbankruptcy but causes some strategic default tooccur. Thus when information is incomplete,no contract can eliminate both bankruptcy andstrategic default.

Several papers in the financial contract-ing literature consider alternative ways of re-ducing strategic default. Bolton & Scharfstein(1996b) extend the model to consider the op-timal number of creditors and find that, whenentrepreneurs borrow from multiple creditors,

they are less likely to strategically default. Thisis because each individual creditor has the rightto liquidate the corporation following default,so that strategic default only succeeds if nocreditor liquidates, and this outcome becomesless likely as the number of creditors increases.However, the cost of nonstrategic default riseswhen there are more creditors. Berglof & vonThadden (1994) consider a similar model inwhich the project has both short-term andlong-term debt. Creditors holding short-termversus long-term debt have differing stakes inthe corporation because only those holdinglong-term debt benefit from its future earn-ings. As a result, short-term creditors are morelikely to liquidate following default. Berglof& von Thadden show that entrepreneurs areless likely to default strategically if some ofthe corporation’s creditors hold only short-term debt. (Other articles that explore the ef-fects of financial contracts when bankruptcymay occur include Webb 1991, Bester 1994,Bolton & Scharfstein 1996a, and Hart & Moore1998).

Other papers consider how bankruptcy lawaffects whether entrepreneurs use the econom-ically efficient level of effort in managing theircorporations. Povel (1999) develops a model toanalyze how bankruptcy law affects the trade-off between entrepreneurs’ effort levels andwhether the number of bankruptcy filings is ef-ficient. In his model, corporations may have ei-ther high or low earnings. The best outcome isfor them to file for bankruptcy when earningsare low and to avoid bankruptcy when earningsare high. Entrepreneurs make the bankruptcydecision. They also decide whether to use highor low effort, where high effort increases theprobability of high earnings. But creditors can-not observe entrepreneurs’ effort levels, andthey also do not observe a signal that arrivesconcerning the project’s quality.

There are two possible bankruptcy laws:soft versus tough, corresponding to reorga-nization versus liquidation in bankruptcy.Entrepreneurs are assumed to keep their jobsunder the soft bankruptcy law and lose themunder the tough bankruptcy law.

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When bankruptcy law is soft, Povel (1999)shows that entrepreneurs file for bankruptcywhenever the signal suggests that earnings arelikely to be bad because they are treated wellin bankruptcy. But because they have a softlanding in bankruptcy, they use less effort.In contrast, when bankruptcy law is tough,entrepreneurs avoid bankruptcy regardlessof the signal because filing for bankruptcycosts them their jobs. But then they have anincentive to use high effort to increase theprobability that earnings will be high. Thus fil-tering failure trades off against entrepreneurs’effort level: A tough bankruptcy law results intoo many bankruptcies but efficient effort byentrepreneurs, whereas a soft bankruptcy lawresults in the opposite. Depending on whetherefficient effort by entrepreneurs or efficientlevels of filtering failure is more valuable,either a soft or a tough bankruptcy law couldbe more economically efficient.8

To summarize, theoretical models ofbankruptcy law show that bankruptcy affectsmanagers’ incentive to use effort, to defaultstrategically, to file for bankruptcy at the ef-ficient time, and to make efficient investmentdecisions. The models consider both the effectson economic efficiency of changing the priorityrules in bankruptcy and changing bankruptcylaw in other ways. The results show that, ex-cept in special cases, no one bankruptcy proce-dure results in economically efficient outcomesalong all the dimensions considered.

Proposed Reforms of Bankruptcy Law:Auctions, Options, and Bankruptcyby Contract

A number of authors have argued that theprocedure for reorganizing corporations in

8Berkovitch et al. (1997) explore how bankruptcy law affectsmanagers’ incentives to invest in firm-specific human capital,and Berkovitch & Israel (1999) explore whether creditors orentrepreneurs should have the right to initiate bankruptcy.Triantis (1993) explores how bankruptcy law affects the ef-ficiency of buyers’ and sellers’ incentives to breach contractsand to make reliance investments. Gertner & Scharfstein(1991) explore how bankruptcy law affects investment andwhen additional investment is economically efficient.

bankruptcy in the United States should bereformed to eliminate deviations from theAPR and reduce filtering failure. More specif-ically, the argument is that reorganization inbankruptcy sets up a negotiation between man-agers and creditors that overvalues corporateassets, which results in deviations from the APRoccurring and inefficient corporations beingsaved. The reform proposals advocate substi-tuting market-based methods to value corpo-rate assets in bankruptcy, so that the APR isfollowed (without deviations). They also arguethat old managers should not be allowed to de-cide whether corporations in bankruptcy shutdown or continue to operate.

As an example of how inaccurate valuationslead to deviations from the APR, suppose thetrue value of a corporation’s assets is $8 millionand it has $8 million in high-priority claims and$4 million in low-priority claims. If the assetsare valued at $8 million or less, then high-priority creditors receive all of the assets of thereorganized corporation, whereas low-prioritycreditors and the firm’s old shareholders receivenothing. But if the assets instead are valued at,say, $14 million, then high-priority creditorsreceive only $8 million of the $14 million,or 57% of the assets, low-priority creditorsreceive 29%, and old shareholders receive14%. Thus a high valuation leads to deviationsfrom the APR. In the United States, negotia-tions over reorganization plans in bankruptcyfrequently use inflated valuations because thevoting procedure for adopting a reorganizationplan requires that low-priority creditors andold shareholders vote in favor, and they onlydo so if they receive some payment. But ifa reorganization plan is adopted, then thecorporation continues to operate even if it isinefficient.

Auctions. One reform proposal is to auctionall corporations in bankruptcy. If corporationsare operating when they file, then they wouldbe auctioned as going concerns, and if theyhave shut down, then their assets would be auc-tioned piecemeal. The proceeds of the auctionwould be distributed to creditors and equity


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according to the APR, without deviations. Thewinner of the auction—rather than the oldmanagers—would decide whether to continueto operate the corporation or shut down. Auc-tions would eliminate the distinction betweenreorganization and liquidation in bankruptcy.

Auctions have a number of advantages. Theyimprove economic efficiency by allowing newbuyers to decide whether distressed corpora-tions liquidate or reorganize. Although man-agers and old shareholders always prefer reor-ganization, buyers have an incentive to makeeconomically efficient choices because theyhave their own funds at stake. Using auctionsalso eliminates the overvaluation of corporateassets because all valuations are market based.The reorganization process is also quicker andless costly because there is no need to negoti-ate and vote on reorganization plans (see Baird1986, 1987, 1993; Roe 1983; Jackson 1986;Shleifer & Vishny 1992; Berkovitch et al. 1997,1998; Baird & Rasmussen 2002; and LoPucki2003 for arguments in favor and against usingauctions in Chapter 11).

But a number of problems with bankruptcyauctions have been noted. One example is, iffew bankrupt firms are auctioned, then buyersmay assume that they are lemons and respondwith low bids. This problem may become lesssevere as more auctions occur. Another exam-ple is that auctions may increase market powerin an industry because the most likely buyers forassets of bankrupt corporations are other firmsin the same industry. Finally and most impor-tantly, the theoretical models discussed abovedo not support the idea that strict application ofthe APR in bankruptcy reorganization increasesefficiency. Instead, using the APR without de-viations may result in too much liquidation oc-curring, rather than too much reorganization.

Options. Bebchuk (1988, 2000) proposedusing options to value the assets of corporationsin bankruptcy and eliminate deviations fromthe APR. To illustrate, suppose a bankrupt firmhas 100 shares of equity and 100 creditors whoare each owed $1. Also suppose the reorganizedfirm will have 100 new shares of equity. Under

the options approach, each owner of an oldshare is given an option to purchase a newshare for $1. These options must be exercisedat a particular date. If old shareholders thinkthat the new shares will be worth less than $1,they will not exercise their options. Then thebankrupt firm’s debt is converted into sharesin the reorganized corporation, so that eachcreditor ends up with one new share worth lessthan $1 and old shareholders receive nothing.But if old shareholders think that the newshares will be worth more than $1, then theywill exercise their options. Each creditor thenends up with $1 and each old shareholder endsup with 1 new share of the reorganized firmminus $1. A market for the options would op-erate before the exercise date, so that creditorsand shareholders would have a choice betweenexercising their options or selling them tooutside investors. Regardless of whether theoptions are exercised, the APR is followed.This is because regardless of who ends upowning the new shares, the old shareholdersreceive nothing unless creditors are repaid infull. The same procedure can be extended tomultiple classes of creditors, where each classof creditors is given options to purchase theclaims of the next highest class of creditors.

In Bebchuk’s proposal, there is no explicitmethod for determining whether the old man-agers will be replaced and how the reorganizedfirm’s assets will be used. After the options areexercised, the new shareholders elect a boardof directors that hires a manager—the sameprocedure as is followed by nonbankrupt firms.Aghion et al. (1992) and Hart et al. (1997) ex-tended Bebchuk’s options scheme to include avote by the new shareholders on how the reor-ganized firm’s assets will be used. Under theirproposal, the bankruptcy judge solicits bids thatcould involve either cash or noncash offers forthe reorganized firm’s new shares or simply of-fers to manage the firm with the new share-holders retaining their shares. The bids are an-nounced at the same time that the options areissued, so that the parties can use the informa-tion contained in the bids in deciding whetherto exercise their options. After the options are

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exercised, new shareholders vote to determinewhich bid is selected.

Contracting about bankruptcy. Bankruptcyis a mandatory procedure in the sense that,when firms become insolvent, the state-supplied bankruptcy procedure must be used.Debtors and creditors are not allowed to con-tract for any alternative dispute-resolution pro-cedure or for any limits on managers’ rightto file for bankruptcy and to choose betweenliquidation and reorganization in bankruptcy.They also cannot contract out of use of theAPR in bankruptcy liquidation. In this sense,bankruptcy differs from other aspects of com-mercial law, where the law provides a set ofdefault rules, but the parties are generally al-lowed to reject the default rules by agreeing onalternatives. A number of authors have arguedthat efficiency would be enhanced if creditorsand debtors could choose their own bankruptcyprocedure, with the choice being made whenthey negotiate their debt contracts. This argu-ment makes sense in light of the contractingmodels discussed above, which show that themost economically efficient bankruptcy proce-dure may vary depending on circumstances.For example, in the Povel (1999) model dis-cussed above, the most economically efficientbankruptcy law could be either soft or tough,depending on circumstances.9

The most radical approach to bankruptcycontracting was suggested by Adler (1993), whoproposed completely abolishing bankruptcy.Instead, debt contracts would incorporate aprocedure to deal with financial distress, whichAdler calls “chameleon equity.” If a corpora-tion became insolvent, its lowest-priority debtclaims would be converted to equity and oldequity would be eliminated. If the corpora-tion was still insolvent, the next-higher-prioritydebt claims would be converted into equity andlower-priority debt claims would be eliminated.

9Other contracting models discussed above also consider op-timal bankruptcy law. See also Aghion & Hermalin (1990)and Rasmussen (1992).

The process would continue until the corpora-tion is solvent again. These changes would pre-serve the APR. Creditors would no longer havethe right to sue corporations for repayment fol-lowing default. As an example, suppose a cor-poration’s assets are worth $1,000,000, but itis insolvent because it has $900,000 in seniordebt and $500,000 in junior debt. Then the se-nior debt would remain intact, the junior debtwould be converted into equity, and the old eq-uity would be eliminated.

The proposal has a number of obvious prob-lems. The most important is strategic default:managers gain from getting rid of the corpora-tion’s debt, so that they have an incentive toinvoke the procedure too often. The lack ofa penalty for default would undermine creditmarkets and greatly reduce credit availability. Inaddition, inefficient corporations would neverbe forced to shut down because they couldalways convert their debt to equity. Overall,the proposal suggests the importance of hav-ing a mandatory bankruptcy procedure. Al-though it might improve efficiency to allowdebtors and creditors to contract about specificsof bankruptcy, it would not improve efficiencyto eliminate bankruptcy completely.

Schwartz (1997) considers a model in whichbankruptcy reorganization retains its currentform, but debtors and creditors can contractin advance to change specific aspects of thelaw. In particular, creditors could contract inadvance to pay shareholders a predeterminedamount if managers choose liquidation ratherthan reorganization in bankruptcy. In effect,this means that the parties could contract in ad-vance to deviate from the APR in bankruptcy.All other aspects of bankruptcy law wouldremain unchanged.

Schwartz shows that this type of contract canreduce filtering failure by reducing the numberof corporations that reorganize in bankruptcywhen they should liquidate. This is becausethe predetermined payment causes managersof inefficient corporations to change theirpreferences from liquidation to reorganization,whereas managers of efficient corporations stillprefer reorganization because it generates a


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larger return than the predetermined payment.But the result is somewhat fragile becauseif the predetermined payment is too high,then even managers of efficient corporationswill prefer liquidation over reorganization.Thus allowing contracting over some aspectsof bankruptcy law can sometimes improveeconomic efficiency relative to the currentmandatory bankruptcy regime.

Financial crises and “systemic” bankruptcy.The previous discussion assumes that bankrupt-cies occur in isolation. However, in a financialcrisis, many corporations experience financialdistress simultaneously because credit becomesunavailable or interest rates drastically increase.Many of the corporations that are financiallydistressed during financial crises would be prof-itable in normal conditions. In this situation,the main goal of bankruptcy policy changesfrom that of reducing filtering failure to thatof keeping financially distressed corporations inoperation because shutdown spreads economicdisruption and worsens the severity of the cri-sis. Stiglitz (2001) and Miller & Stiglitz (2010)discuss the possibility of a “super Chapter 11”bankruptcy procedure that would be put intoeffect during financial crises. It would keep fi-nancially distressed corporations operating byspeeding up bankruptcy procedures, retainingexisting managers, and converting corporatedebt into equity. This type of procedure wouldalso reduce the need for government-financedbailouts of distressed corporations in times of fi-nancial crisis and provide governments with anadditional tool for stabilizing the economy.10

Empirical Research onCorporate Bankruptcy

Empirical research on corporate bankruptcyhas concentrated on measuring the costs of

10Chapter 11 is the U.S. bankruptcy procedure for saving fi-nancially distressed corporations. See Claessens et al. (2001)and Halliday & Carruthers (2009) for discussions of corpo-rate bankruptcy procedures in the context of the Asian finan-cial crisis and the 2008 financial crisis.

bankruptcy and the size and frequency of de-viations from the APR.11

Bankruptcy costs. Bankruptcy costs can bedivided into direct and indirect costs. Directcosts include the legal and administrative costsof bankruptcy, whereas indirect costs includeall the costs of bankruptcy-induced disrup-tions, including asset disappearance, loss of keyemployees, reduced access to capital, and in-vestment opportunities forgone because man-agers’ time is spent on the bankruptcy. Weiss(1990) studied 37 corporate reorganizationsduring the early 1980s and found that the di-rect costs of bankruptcy averaged 3.1% of thecombined value of debt plus equity. Bris et al.(2006) found that bankruptcy costs were sim-ilar in liquidations and reorganizations. Indi-rect bankruptcy costs are not reported and mustbe inferred, but they are likely to be muchgreater than direct bankruptcy costs. White(1983) solved for upper-bound expressions onindirect bankruptcy costs; her results suggestthat indirect costs may be as high as 20 timesthe direct costs of bankruptcy. Other studiesprovide evidence that bankruptcy is very dis-ruptive to corporations, which implies that in-direct bankruptcy costs must be very high. Ang& Chua (1981) and Gilson (1990) found that theturnover rates of top executives and directorswere much higher for large corporations thatreorganized in bankruptcy than for corpora-tions not in bankruptcy. Carapeto (2000) foundthat when large corporations in bankruptcy of-fer multiple reorganization plans, the total pay-off offered to creditors declines by 14% betweenthe first and the last plan. This implies thatthe marginal costs of remaining in bankruptcylonger increase quickly. Hotchkiss (1995) foundthat reorganizing in bankruptcy does not nec-essarily solve the financial problems of dis-tressed corporations because one-third of hersample of firms that successfully reorganized

11There is little empirical research on the effect of bankruptcylaw on credit markets for large corporations (but seeDavydenko & Franks 2008, which uses cross-country data).I discuss this topic in detail in the next section.

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required further restructuring within a fewyears. Her results suggest that some ineffi-cient firms are reorganizing in bankruptcy eventhough they should liquidate (see also Ang et al.1982, LoPucki 1983, and Franks & Torous1989).

Deviations from the absolute priority rule.Several papers provide evidence concerning thefrequency and size of deviations from the APRin corporate reorganizations. The size of devia-tions from the APR is measured by the amountpaid to equity in violation of the APR divided bythe total amount distributed to creditors underthe reorganization plan. For example, supposea corporation in bankruptcy owes $1,000,000to creditors, but its reorganization plan payscreditors $500,000 and gives old sharehold-ers $50,000. Then deviations from the APRamount to $50,000/500,000 or 10%.

Weiss (1990) examined 31 corporations thatadopted reorganization plans in bankruptcy, ofwhich 28—or 90%—involved deviations fromthe APR. Eberhart et al. (1990), LoPucki &Whitford (1990), Betker (1995), and Carapeto(2000) similarly found deviations from the APRin around three-quarters of large corporations’bankruptcy reorganization plans. Eberhartet al. (1990) and Betker (1995) found that theaverage deviation from the APR was in therange of 3% to 7%.

How do deviations from the APR relateto the financial condition of corporations inChapter 11? This relationship can be estimatedby regressing the amount paid to equity asa fraction of unsecured creditors’ claims onthe amount paid to unsecured creditors as afraction of their claims (i.e., the payoff rate tounsecured creditors). If the APR was alwaysperfectly followed, the estimated relationshipwould run along the horizontal axis as longas the payoff rate to unsecured creditors wasless than 100%, but would become verticalat a payoff rate of 100%. But when there aredeviations from the APR, shareholders arelikely to receive something even when unse-cured creditors’ payoff rate is low, and theirpayoff is likely to increase quickly as unsecuredcreditors’ payoff rate approaches 100%.

This relationship has been estimated byWhite (1989), Betker (1995), and Bris et al.(2006). As predicted, the results show thatshareholders receive a minimum payoff of about5% of unsecured creditors’ claims, and thattheir payoff rate increases as unsecured cred-itors’ payoff rises.12 Betker also finds that devi-ations from the APR are smaller when a higherproportion of the firm’s debt is secured. Briset al. (2006) also find that deviations from theAPR are larger when managers own more eq-uity in the corporation (Gilson et al. 1990,Franks & Torous 1994, Tashjian et al. 1996,and Morrison 2009 provide empirical evidencecomparing out-of-bankruptcy workouts to in-bankruptcy reorganizations).

II. PERSONAL BANKRUPTCY

Like corporate bankruptcy law, personalbankruptcy law determines the total amountthat individual debtors must repay—the sizeof the pie—and how the pie is divided amongcreditors. A larger pie benefits future borrowersby increasing the future supply of credit andlowering interest rates. But a larger pie is costlyto existing debtors because high repaymentobligations may reduce debtors’ consumptionto the point that illnesses go untreated andturn into disabilities, debtors’ families losetheir homes and their neighborhood ties, anddebtors’ children leave school in order to work.High repayment obligations may also causedebtors to work less and may change theirdecisions concerning whether to consume orinvest their wealth and whether to choose safeor risky investments. The division of the piealso has efficiency implications. When debtorsdefault, creditors have an incentive to raceagainst each other to be first to collect, becausebankruptcy filings terminate collection efforts.But aggressive collection efforts can harm

12These results are also consistent with the bargaining modelof Chapter 11 described by Bebchuk & Chang (1992), inwhich equity gets a low payoff in return for giving up itsright to delay adoption of the reorganization plan and getsmore as equity’s option on the corporation comes closer tobeing in the money.


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debtors because they may quit their jobs ifcreditors garnish wages or lose their jobs ifcreditors repossess their cars.

Some of the economic objectives of personalversus corporate bankruptcy are the same,but there are important differences. Becauseindividuals in bankruptcy never liquidate,there is no issue of filtering failure in personalbankruptcy. Also, an important objectiveof personal bankruptcy law that does notexist in corporate bankruptcy is to providepartial consumption insurance to bankrupts.Bankruptcy-provided consumption insurancemakes individuals worse off when their abilityto repay is high and better off when their abilityto repay is low.

Personal bankruptcy law specifies a set ofexemptions that determine how much of theirfinancial wealth and future earnings individualbankrupts are allowed to keep. Exemptions existonly in personal bankruptcy; as discussed above,there are no bankruptcy exemptions for cor-porations.13 Although higher exemption lev-els reduce the size of the pie, they benefitdebtors by raising their minimum consumptionlevels. Exemptions also affect debtors’ incen-tives to work and use their human capital afterbankruptcy.

Insurance and Work Effort Effectsof Personal Bankruptcy Law

Most models of economically efficient personalbankruptcy law14 solve for optimal bankruptcyexemption levels, i.e., the optimal size of thepie. They ignore the question of how the pieshould be divided by assuming that bankruptshave only one creditor. Suppose there is only

13Corporations that reorganize in bankruptcy are allowed tokeep some of their assets, but the justification is that thesecorporations will pay creditors more from their future earn-ings than creditors would receive in liquidation.14This section draws on Rea (1984), Jackson (1986), White(2005), Fan & White (2003), Wang & White (2000), andAdler et al. (2000). Rea (1984) was the first to suggest the in-surance justification for personal bankruptcy law. See Livshitset al. (2007) and Athreya (2002) for general equilibrium mod-els of personal bankruptcy law.

one personal bankruptcy procedure that obligesbankrupts to repay from both financial wealthand postbankruptcy earnings, but provides ex-emptions for both. (These assumptions differfrom U.S. bankruptcy law, where the most com-monly used personal bankruptcy procedure ex-empts all future earnings from the obligation torepay—this is referred to as the “fresh start.”15)Not assuming that all future wages are exemptallows us to consider whether/when the freshstart is economically efficient.

Assume that the wealth exemption inbankruptcy is X dollars, regardless of the formof the wealth, and the exemption for fu-ture earnings is x percent of postbankruptcyearnings (Hynes 2002 discusses alternate waysof taxing debtors’ post-bankruptcy earnings).Debtors are obliged to repay from earnings fora fixed number of years. Filing for bankruptcycosts debtors S dollars. Debtors in bankruptcyare required to use all of their nonexemptwealth and earnings to repay prebankruptcydebt, up to the amount owed. Whatever debtis unpaid at the end of the repayment period isdischarged.

Suppose in period 1, individuals borrow afixed amount B at interest rate r from a sin-gle lender, to be repaid in period 2. The in-terest rate is determined by the lender’s zeroprofit constraint. In period 2, wealth is uncer-tain. Individual debtors learn their actual wealthat the beginning of period 2, they then decidewhether to file for bankruptcy, and, finally, theychoose their period 2 labor supply. Period 2labor supply depends on whether they file forbankruptcy. (Period 2 is assumed to last for theentire period when they are obliged to repay inbankruptcy.)

Individuals’ utility depends positively onconsumption and negatively on labor supply ineach period, and they are assumed to be risk

15The U.S. bankruptcy procedure that exempts all futureearnings is Chapter 7, whereas the procedure that requiresindividual bankrupts to use future earnings to repay isChapter 13. Since 2005, some higher-income bankrupts havebeen barred from filing under Chapter 7. See White (2007)for discussion of bankruptcy reform.

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averse. They have an incentive to work less af-ter filing for bankruptcy because their earningsare subject to the “bankruptcy tax” of x%. Butthey also have an incentive to work more afterfiling because bankruptcy reduces their wealth.Economists generally assume that the formereffect exceeds the latter (the substitution effectexceeds the wealth effect), so that individuals arepredicted to work less following bankruptcy.

Debtors decide whether to file forbankruptcy depending on which alternativemaximizes their utility. There is a thresholdlevel of period 2 wealth W where they areindifferent between filing or not filing; theyfile if their wealth is below the threshold anddo not file otherwise. When debtors’ earningsare higher, the threshold wealth level rises.Figure 1 shows debtors’ period 2 consumptionas a function of their period 2 wealth. Con-sumption is divided into three regions: region3 where debtors repay in full, region 2 wherethey file for bankruptcy and repay from bothwealth and future earnings, and region 1 wherethey file for bankruptcy and repay only fromfuture earnings because all of their wealth isexempt. The boundary between regions 2 and3 occurs at W . There is a discontinuous dropin consumption at W because debtors workless and earn less in bankruptcy.

How do the wealth and earnings exemptionsprovide debtors with consumption insurance?Raising the wealth exemption X reducesdebtors’ consumption in region 3 becausecreditors raise interest rates on loans, butincreases debtors’ consumption in region 2because more of their wealth is exempt. Con-sumption is unaffected in region 1 because all ofdebtors’ wealth is exempt. In contrast, raisingthe earnings exemption reduces debtors’ con-sumption in region 3 for the same reason, butincreases debtors’ consumption in both regions2 and 1 because they keep a higher percent oftheir earnings. This means that the consump-tion insurance provided by a higher earningsexemption is more valuable than the consump-tion insurance provided by a higher wealthexemption because only a higher earningsexemption raises debtors’ consumption in

X+S WˆW

C

Region 1 Region 2 Region 3

Figure 1The insurance effect of bankruptcy. The diagram shows period 2 consumptionon the vertical axis and period 2 wealth on the horizontal axis. Labor supply isassumed to be higher outside of bankruptcy than in bankruptcy. Debtors filefor bankruptcy in regions 1 and 2 and avoid bankruptcy in region 3.

region 1 where it is lowest. In addition,debtors work more following bankruptcy whenthe earnings exemption is higher becausetheir earnings are less highly taxed. Debtorstherefore repay more in bankruptcy when x ishigher, which reduces the cost of consumptioninsurance.

These results suggest that optimal personalbankruptcy law should have a relatively highexemption for earnings and a relatively lowexemption for wealth because the earnings ex-emption provides more valuable consumptioninsurance and because a higher earnings exemp-tion causes debtors to work more in bankruptcy.The higher value of the earnings exemptionrelative to the wealth exemption suggests aneconomic justification for the fresh start.16

16See Wang & White (2000) for a simulation. The earningsexemption would not necessarily provide more valuable con-sumption insurance if a range of low earnings were entirelyexempt in bankruptcy because earnings in this range wouldbe unaffected by the exemption level.


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This model of bankruptcy yields severaltestable hypotheses. First, in jurisdictions thathave higher wealth exemptions in bankruptcy,consumption is more fully insured and there-fore is predicted to be less variable. Second,in jurisdictions that have higher wealth exemp-tions, lending is less profitable because defaultrates are higher. Therefore lenders are pre-dicted to charge higher interest rates and re-duce the supply of credit. Third, if debtors arerisk averse, then they are predicted to borrowmore when the downside risk of borrowing islower. This means that demand for credit is pre-dicted to be higher in jurisdictions with higherwealth exemptions. Similarly, if potential en-trepreneurs are risk averse, then they are morewilling to take the risk of going into businessif higher wealth exemptions reduce the costof business failure. Jurisdictions with higherwealth exemptions are therefore predicted tohave more entrepreneurs. These predictionshave been tested (see below).

Other Theoretical Issues

Models of the effects of personal bankruptcylaw have posed a number of other issues,including whether debtors default withoutfiling for bankruptcy, whether bankruptcylaw should allow debtors to waive their rightto file for bankruptcy, whether bankruptcyencourages strategic behavior by debtors, andhow the right to file for bankruptcy can bevalued as an option. Some of these issuesare similar to issues already discussed in thecontext of corporate bankruptcy law.

Default versus bankruptcy. In the previoussection, debtors were assumed to choose be-tween defaulting and filing for bankruptcy ver-sus repaying in full. But in reality, debtors maydefault without filing for bankruptcy or defaultfirst and file for bankruptcy later. When debtorsdefault, creditors attempt to collect, and theirmost important legal weapon is garnishment ofa fraction of debtors’ earnings. Debtors oftenrespond to garnishment by filing for bankruptcybecause filing ends garnishment.

White (1998b) used an asymmetric informa-tion model to examine whether, in equilibrium,debtors may default but not file for bankruptcy.The model assumes that there are two types ofdebtors, As and Bs. Both types decide whetherto default, and, following default, creditorsdecide whether to garnish debtors’ wages.Garnishment is assumed to be costly for cred-itors. The two types of debtors differ in howthey respond to garnishment: type As repay infull, whereas type Bs file for bankruptcy andrepay nothing. Creditors are assumed unableto identify individual debtors’ types when theydefault, so they must respond in the same wayto all defaults. I show that, in equilibrium, alltype B debtors default, at least some type Adebtors also default, and creditors play mixedstrategies of sometimes instituting garnish-ment in response to default and sometimes not.This means that, in equilibrium, some debtorsdefault but do not file for bankruptcy. Thesedebtors obtain the benefit of debt forgivenesswithout having their wages garnished andwithout filing for bankruptcy. The modelsuggests that having a personal bankruptcysystem encourages some debtors to defaulteven when they can afford to repay their debts.

Waiving the right to file for personalbankruptcy. In the corporate bankruptcycontext, researchers have argued that debtorsshould be allowed to contract with creditorsabout bankruptcy procedures (see the dis-cussion above). In the personal bankruptcycontext, the issue is whether efficiency couldbe improved by allowing debtors to waive theirright to file for bankruptcy.17

Would individual debtors ever choose toissue waivers when making loan contracts?Doing so would mean that debtors could stilldefault, but they could not end creditors’collection efforts by filing for bankruptcy. Themain advantage to debtors of issuing waivers

17In the United States, waivers are unenforceable and therules of bankruptcy cannot be changed by contract. See Rea(1984), Jackson (1986), Adler et al. (2000), and Hynes (2004)for discussions.

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is that more credit would be available at lowerinterest rates because debtors are less likely todefault. But debtors who issued waivers wouldface more risk in their period 2 consumption,i.e., consumption would be higher in region3 of Figure 1 and lower in regions 1 and 2.Debtors who issued waivers would probablywork more to reduce their risk. This suggeststhat risk-averse debtors would not issuewaivers, but risk-neutral debtors might.

However, there are a number of external-ity arguments that support the current policyof prohibiting waivers. First is that waivers maymake individual debtors’ families worse off be-cause spouses and children bear most of thecost of reduced consumption if the debtor’swealth turns out to be low, but debtors maynot take this into account in deciding whetherto issue waivers. Second, debtors may underes-timate the probability of having low wealth inthe future, so that they may issue waivers whenit is against their self-interest. Third, prohibit-ing waivers benefits the government becauseits expenses for social safety net programs arelower when debtors can file for bankruptcy andavoid repaying their debts.18 Finally, allowingwaivers might have adverse macroeconomic ef-fects. This is because if many debtors simulta-neously had a bad draw on wealth, all wouldreduce their consumption simultaneously andthe economy might go into a recession.

The option value of bankruptcy. Debtors’right to file for bankruptcy can be expressed asa put option. If debtors’ future wealth turns outto be high, they repay their debts in full, butif their future wealth turns out to be low, theycan exercise their option to “sell” the debt tocreditors by filing for bankruptcy. The price ofexercising the put option is the cost of filing plusthe amount that debtors are obliged to repay inbankruptcy. Also, because debtors in the UnitedStates can only file for bankruptcy once every six

18Posner (1995) discusses the relationship between the in-surance provided by bankruptcy and government-providedsocial insurance programs.

years, they gain from timing their bankruptcydecisions.

White (1998a) calculated the value of theoption to file for bankruptcy for a representa-tive sample of U.S. households during the early1990s. The results showed that at the time,many more households had a positive optionvalue of filing for bankruptcy than actually filed.

Bankruptcy and incentives for strategic be-havior. A problem with personal bankruptcylaw—particularly in the United States—is thatit may encourage debtors to behave strategi-cally by filing even when they can afford to re-pay their debts. Strategic behavior by debtorsundermines the goal of punishing debtors forbankruptcy. In general, the higher are thewealth and earnings exemptions in bankruptcy,the stronger are debtors’ incentives to be-have strategically. In the United States post-bankruptcy earnings are completely exempt formost debtors, and some U.S. states also havehigh or unlimited exemptions for wealth. As aresult, many debtors in the United States gainfrom behaving strategically. Using the previ-ous notation and assuming that the earningsexemption is 100%, debtors’ financial benefitfrom filing for bankruptcy is

Financial benefit

= max{D − max[W − X , 0], 0} − S. 1.

Here D is the amount of debt dischargedin bankruptcy, max[W−X,0] is the value ofnonexempt assets that debtors must give up inbankruptcy, if any, and S is the cost of filing.

White (1998a,b) calculated the financialbenefit of filing for bankruptcy for a representa-tive sample of U.S. households, using data fromthe early 1990s. Bankruptcy costs were assumedto be zero. The results showed that approx-imately one-sixth of U.S. households wouldbenefit from filing for bankruptcy. If debtorspursued various strategies to increase their fi-nancial gain from filing, then the proportionthat benefited from bankruptcy rose from one-sixth to one-half. These results provide someexplanation for why the United States has high


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bankruptcy filing rates, but raise the oppo-site question of why filing rates are not evenhigher.

Empirical Research on Personal andSmall Business Bankruptcy

Most of the empirical research on personalbankruptcy uses U.S. data and makes use ofthe fact that exemption levels for wealth varywidely across U.S. states. (Other aspects of U.S.bankruptcy law are uniform across states.19)This variation allows researchers to investigatehow differences or changes in wealth exemp-tions across states affect a variety of behaviorsby debtors and creditors. The studies includeresearch on how bankruptcy law affects behav-ior and on the determinants of bankruptcy fil-ings. In this section, I review empirical researchon personal and small business bankruptcy.

Bankruptcy law as insurance for consump-tion and wealth. The model discussed aboveshowed that higher exemption levels providedebtors with additional insurance againstnegative financial shocks that would reducetheir wealth and their consumption levels. Thisis because when negative shocks occur, debtorsliving in states with higher exemption levelscan have their debts discharged in bankruptcywhile keeping more of their assets. This meansthat the variance of household consumptionover time in particular U.S. states should besmaller, i.e., less risky, in states with higherexemption levels. Grant & Koeniger (2009)tested this hypothesis by computing the vari-ance of household consumption by state-year

19The U.S. bankruptcy reform of 1978 adopted uniform ex-emption levels for wealth in bankruptcy, but allowed statesto opt out of the federal exemptions and choose their own.All states did so by around 1980, but around one-third ofthe states allow bankruptcy filers to choose between the stateand the federal exemption levels. Other aspects of bankruptcylaw are uniform across states, because the U.S. Constitu-tion reserves for the federal government the right to adoptbankruptcy laws. See Posner (1997) for discussion of the his-tory and political economy of the 1978 reform. Hynes et al.(2004) estimate a model that explains states’ exemption levels.

for all U.S. states over a 20-year period. Thenthey estimated a regression explaining thechange in the variance of consumption as afunction of exemption levels by state-year,plus control variables. They found that instates with higher exemption levels, changesin the variance of consumption were lower,thus supporting the hypothesis that higherexemption levels provide households withadditional consumption insurance.

Insurance effects of bankruptcy: en-trepreneurial behavior, divorce, and healthinsurance. When individuals start or own un-incorporated businesses, they incur businessdebts for which they are personally liable. Thismakes entrepreneurs’ wealth more risky be-cause wealth increases if the business succeedsand falls if it fails. The personal bankruptcysystem provides partial insurance for this typeof risk because if failure occurs, entrepreneurscan file for personal bankruptcy and have boththeir business and personal debts discharged.States that have higher wealth exemptionsprovide even more wealth insurance throughbankruptcy; in those with the highest exemp-tions, entrepreneurs can keep their homes evenif their businesses fail. Thus risk-averse individ-uals are predicted to be more likely to own orstart businesses if they live in states with higherwealth exemptions.

Fan & White (2003) tested this hypothesis,focusing on home equity exemptions—whichare the largest exemptions in most U.S. states.They found that homeowners are 35% morelikely to own businesses if they live in stateswith high or unlimited home equity exemptionsrather than low exemptions. They also found asimilar effect for renters. Armour & Cumming(2008) found similar results using data for 15countries in Europe and North America.

The additional wealth insurance providedby bankruptcy in states with higher exemp-tion levels also affects behavior in other ways.Being married provides individuals with insur-ance against negative financial shocks becauseshocks are unlikely to affect both spouses atthe same time. But the insurance provided by

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marriage is less valuable to individuals livingin states with higher exemption levels becausebankruptcy in these states provides more of thesame type of insurance. Couples in these statestherefore gain less from marriage and havestronger incentives to get divorced. Traczyn-ski (2011) tested the divorce hypothesis andfinds that increases in state exemption levelsfrom 1989 to 2005 resulted in 200,000 addi-tional divorces during the period. Similarly, in-dividuals have less incentive to buy health insur-ance if they live in states with higher exemptionlevels. Having health insurance provides themwith financial protection against negative med-ical shocks, but the insurance is less valuable ifthey live in states with higher exemption levelsbecause bankruptcy provides more of the sametype of insurance. Mahoney (2011) shows thatindividuals are less likely to buy health insur-ance if they live in states with higher exemptionlevels.

Effects of bankruptcy on postbankruptcy la-bor supply. In the theoretical model discussedabove, debtors were predicted to work less afterfiling for bankruptcy if they are required to re-pay debt from future earnings. However, U.S.law differs from the assumptions of the modeldiscussed above because most bankruptcy filersare not required to repay from postbankruptcyearnings, but are often subject to wage gar-nishment outside of bankruptcy. This meansthat filing for bankruptcy reduces rather thanincreases their obligation to repay debt fromearnings, and as a result they are predicted towork more after filing. Han & Li (2007) ex-amined empirically how filing for bankruptcyaffects debtors’ labor supply. They found thatdebtors did not increase their labor supply afterfiling for bankruptcy. Their results thus under-mine the argument that debtors should have afresh start in bankruptcy (a 100% exemption forpostbankruptcy wages) because the fresh startdoes not increase debtors’ postbankruptcy workeffort.

What triggers bankruptcy? The model dis-cussed above implies that debtors are more

likely to file for bankruptcy when their financialbenefit from filing is higher. More specifically,debtors’ financial benefit from filing depends onthe amount of debt discharged in bankruptcy,their wealth relative to the wealth exemption,and bankruptcy costs. But their financial bene-fit does not depend on their future earnings. Analternative model of bankruptcy decisions, pro-posed by Sullivan et al. (1989), is that debtorsfile only when their earnings fall or their ex-penses rise to the point where it is impossible forthem to repay. In this view, debtors do not planin advance for bankruptcy, so that the impor-tant factors affecting the bankruptcy decisionare ability to pay and whether adverse events—such as job loss, illness, or divorce—have re-cently occurred.

The two models can be tested against eachother because the financial benefit model pre-dicts that wealth and debt levels determinewhether debtors file for bankruptcy, whereasthe adverse events model predicts that abilityto pay and adverse events are the most im-portant determinants. Fay et al. (2003) testedthe two models using household-level paneldata. They found that debtors are significantlymore likely to file for bankruptcy when theirfinancial benefit from filing is higher. But theyalso found evidence that ability to pay affectsbankruptcy decisions—households with higherincomes were less likely to file and those whoseincome fell were more likely to file. Theyalso tested whether adverse events affect thebankruptcy decision and found that neither jobloss nor illness of the household head or spousein the previous year was significantly relatedto bankruptcy. But a divorce in the previousyear was found to increase the probability ofbankruptcy. Thus the study supports the hy-potheses that financial benefit and ability to payaffect the bankruptcy decision, but it does notsupport the hypothesis that adverse events trig-ger bankruptcy filings.20

20In more recent papers, Keys (2009) argues that job lossincreases debtors’ probability of filing for bankruptcy in thefollowing year and Fisher & Lyons (2006) argue that divorceincreases the probability of bankruptcy.


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Researchers have also examined how stigmaaffects bankruptcy filings. Fay et al. (2003)used the aggregate bankruptcy filing rate in thehousehold’s region during the previous year asan inverse proxy for the level of bankruptcystigma. The idea is that when more filingsoccur in a region, people are more likely tohear about bankruptcy from friends or rela-tives and they interpret the additional infor-mation as implying that less stigma is attachedto bankruptcy. Fay et al. found that, in regionswith lower bankruptcy stigma, households weresignificantly more likely to file (other stud-ies of the effect of stigma and information onbankruptcy filings include Gross & Souleles2002 and Cohen-Cole & Duygan-Bump 2009).

Ausubel & Dawsey (2004) used creditcard data to examine debtors’ decisions todefault and to file for bankruptcy. In theirmodel, debtors first decide whether to default,and then, conditional on default, they decidewhether to file for bankruptcy. They referto default without bankruptcy as informalbankruptcy. Ausubel & Dawsey find thatwealth exemptions mainly affect debtors’default decisions, whereas restrictions onthe fraction of wages that can be garnishedmainly affect debtors’ bankruptcy decisions.These results are not surprising becausewealth exemptions apply both in bankruptcyand out of bankruptcy, whereas garnishmentrestrictions only apply outside of bankruptcy(because filing for bankruptcy ends wagegarnishment completely). Ausubel & Dawsey’sresults provide empirical evidence supportingboth the economic model of the bankruptcydecision and the hypothesis that some debtorsdefault without filing for bankruptcy (otherpapers that examine the bankruptcy filingdecision include Buckley 1994, Buckley &Brinig 1998, Domowitz & Sartain 1999, Fisher2009, and Lefgren & McIntyre 2009).

Bankruptcy and credit markets. Wealth ex-emptions also affect both demand for andsupply of credit. When wealth exemptionsare higher, debtors are more likely to filefor bankruptcy, and this makes lending less

attractive. Creditors respond by raising interestrates and/or reducing the supply of credit. Buthigher wealth exemptions reduce the downsiderisk of borrowing and therefore cause debtors—if they are risk averse—to demand more credit.

Gropp et al. (1997) examined the effect ofwealth exemptions on consumer credit markets.They found that households were significantlymore likely to be turned down for credit if theylived in states with high- rather than low-wealthexemptions. Interest rates were also found to behigher in states with high-wealth exemptions,but the size of the effect depended strongly ondebtors’ wealth. Low-wealth households paidhigher interest rates if they lived in states withhigh- rather than low-wealth exemptions, buthigh-wealth households paid the same interestrates regardless of the exemption level. In ad-dition, households with low wealth borrowedless if they lived in states with high- rather thanlow-wealth exemptions, but households withhigh wealth borrowed more. These results sug-gest that when states adopt high-wealth exemp-tions, lenders respond by redistributing creditfrom low-wealth to high-wealth households.Thus although policy-makers often think thathigh-wealth exemptions help the poor, in factthey appear to harm poor debtors and help richones.

Other studies examine the effect of wealthexemptions in bankruptcy on specialized creditmarkets, of which one is the market for smallbusiness loans. Loans for small businesses arepredicted to be affected by wealth exemptionsbecause these loans are personal liabilities of thebusiness owner whenever the business is non-corporate. Berkowitz & White (2004) foundthat small businesses were more likely to beturned down for loans if they were located instates with high-wealth exemptions. Also smallbusinesses paid higher interest rates for loansin these states. These results, combined withthe effect of bankruptcy on entrepreneurial be-havior, suggest that higher wealth exemptionsare a double-edged sword for small businesses:They encourage more individuals to becomeself-employed, but reduce their businesses’ ac-cess to credit.

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One credit market in which wealth ex-emptions are less likely to be important is themarket for mortgages. Wealth exemptions arepredicted not to affect the terms of mortgagebecause when a house is sold following mort-gage default, the proceeds are used to repaythe mortgage in full before the homeownerbenefits from the wealth exemption. But ex-emptions affect the mortgage market indirectlybecause bankruptcy delays foreclosure andtherefore makes it more expensive for lenders.Berkowitz & Hynes (1999) and Lin & White(2001) both examined this issue, but foundcontradictory results. Chomsisengphet & Elul(2006) found that wealth exemptions had noeffect on mortgage markets when they alsocontrolled for borrowers’ credit scores in theirregression models. They argue that creditscores are correlated with wealth exemptions,so that the effect of exemptions is biasedupward when credit scores are omitted.

Bankruptcy also affects debtors’ access tocredit after filing because U.S. law allows fil-ings to remain on debtors’ credit records for upto 10 years. Han & Li (2011) examine how filingfor bankruptcy affects postbankruptcy access tocredit. They find that debtors borrow less andpay more for loans following bankruptcy andthat the effect persists for the entire 10-yearperiod. This suggests that allowing bankruptcyfilings to remain on debtors’ credit recordsfor 10 years is a nontrivial punishment forbankruptcy.

Wealth exemptions in bankruptcy also affectthe composition of debtors’ portfolios. Whenexemptions are higher, households have an in-centive both to hold more assets and to holdmore debt. They prefer to hold both assets anddebt rather than using the assets to repay thedebt because debt is discharged in bankruptcyif it is unsecured, but households are allowedto keep assets in bankruptcy as long as they areexempt. Lehnert & Maki (2002) test whetherhouseholds in states with higher wealth exemp-tions simultaneously hold more debt and moreassets—a behavior that they call borrowing tosave. They find evidence that more households

borrow to save in states with higher wealthexemptions.

Bankruptcy and homeowning. Prior to2005, homeowners in financial distress coulduse bankruptcy to save their homes. Becauseunsecured debts are discharged in bankruptcy,filing increased homeowners’ ability to maketheir mortgage payments and keep their homes.But in 2005, a reform of bankruptcy lawraised the cost of filing and forced some filerswith high earnings to use some of their post-bankruptcy income to repay unsecured debt.Thus the reform was predicted to cause de-fault rates on mortgages to rise. Li et al.(2010) tested this prediction and found thatdefault rates on mortgages increased afterbankruptcy reform, particularly for homeown-ers with high incomes. Morgan et al. (2011)found that foreclosure rates also increased af-ter the reform. Thus the 2005 bankruptcy re-form caused mortgage default and foreclosureto rise even before the start of the financialcrisis.

Why have U.S. bankruptcy filings increasedso sharply since 1980? The number ofbankruptcy filings in the United States in-creased fivefold between 1980 and 2004. Al-though the various models discussed above pro-vide a number of explanations for why debtorsfile for bankruptcy, none can explain the largeincrease in the number of filings over time.More adverse events cannot explain the increasebecause the unemployment rate, the divorcerate, and the fraction of households lackinghealth insurance did not increase over the pe-riod. Higher financial benefit from filing sim-ilarly cannot explain the increase because thefraction of households that would benefit fromfiling for bankruptcy did not increase over theperiod. The most likely explanation for the in-crease in filings was the increase in the aver-age level of unsecured debt held by households,which also rose fivefold over the period. Theincrease in debt levels resulted largely fromhigher credit supply, which in turn was due to a


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combination of technological advances in lend-ing, abolition of limits on interest rates, andchanges in the regulation of the banking indus-try (see Mann 2006, White 2007, and Dick &Lehnert 2010 for discussion).

CONCLUSION

This review started by discussing the threemost important components of bankruptcy—collection resolution of all the bankrupt entity’sdebts, rules for determining how much of thebankrupt entity’s assets and income must beused to repay debts and how payments aredivided among creditors, and punishmentsfor default and bankruptcy. It then examinedhow bankruptcy law affects the behavior ofboth corporations and individuals and howit affects economic efficiency. Corporatebankruptcy law was shown to affect the supplyand demand for business credit; corporate

managers’ incentives to work hard, invest, andtake risks; and whether financially distressedfirms shut down versus continue to operate.Bankruptcy law not only affects financiallydistressed corporations and their creditorsbut also their workers and competitors and—during periods of financial crisis—the entireeconomy. Personal bankruptcy law was shownto affect individual debtors’ incentives to workhard before and after bankruptcy, becomeand remain entrepreneurs, take risks, becomeand remain homeowners, borrow and defaulton debt, obtain health insurance, and get di-vorced. Bankruptcy law also affects the welfareof debtors’ families and neighbors. Becausebankruptcy law affects behavior in so manyways, its effects are often complicated and goboth ways—for example, raising exemptionlevels in bankruptcy encourages individualsto go into business, but also harms smallbusinesses by reducing their access to capital.

DISCLOSURE STATEMENT

The author is not aware of any affiliations, memberships, funding, or financial holdings that mightbe perceived as affecting the objectivity of this review.

ACKNOWLEDGMENTS

The author is grateful for support and hospitality from Cheung Kong Graduate School of Business,Beijing, where she wrote much of this article.

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LS07-Frontmatter ARI 26 September 2011 12:41

Annual Review ofLaw and SocialScience

Volume 7, 2011Contents

The Legislative Dismantling of a Colonial and an Apartheid StateSally Falk Moore � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � 1

Credible Causal Inference for Empirical Legal StudiesDaniel E. Ho and Donald B. Rubin � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � �17

Race and Inequality in the War on DrugsDoris Marie Provine � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � �41

Assessing Drug Prohibition and Its Alternatives: A Guide for AgnosticsRobert J. MacCoun and Peter Reuter � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � �61

The Triumph and Tragedy of Tobacco Control:A Tale of Nine NationsEric A. Feldman and Ronald Bayer � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � �79

Privatization and AccountabilityLaura A. Dickinson � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � 101

The Conundrum of Financial Regulation: Origins, Controversies,and ProspectsLaureen Snider � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � 121

Corporate and Personal Bankruptcy LawMichelle J. White � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � 139

Durkheim and Law: Divided Readings over Division of LaborCarol J. Greenhouse � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � 165

Law and American Political DevelopmentPamela Brandwein � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � 187

The Legal ComplexLucien Karpik and Terence C. Halliday � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � 217

U.S. War and Emergency Powers: The Virtuesof Constitutional AmbiguityGordon Silverstein � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � 237

The Political Science of FederalismJenna Bednar � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � 269

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LS07-Frontmatter ARI 26 September 2011 12:41

The Rights of Noncitizens in the United StatesSusan Bibler Coutin � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � 289

Innovations in Policing: Meanings, Structures, and ProcessesJames J. Willis and Stephen D. Mastrofski � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � 309

Elaborating the Individual Difference Componentin Deterrence TheoryAlex R. Piquero, Raymond Paternoster, Greg Pogarsky, and Thomas Loughran � � � � � � � 335

Why Pirates Are BackShannon Lee Dawdy � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � 361

The Evolving International JudiciaryKaren J. Alter � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � 387

The Social Construction of Law: The European Court of Justiceand Its Legal Revolution RevisitedAntonin Cohen and Antoine Vauchez � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � 417

Indexes

Cumulative Index of Contributing Authors, Volumes 1–7 � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � 433

Cumulative Index of Chapter Titles, Volumes 1–7 � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � 436

Errata

An online log of corrections to Annual Review of Law and Social Science articles may befound at http://lawsocsci.annualreviews.org

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Documents

Corporate and Personal Bankruptcy Lawmiwhite/annurev-lawsocsci-White.pdf · LS07CH08-White ARI 1 October 2011 17:47 Corporate and Personal Bankruptcy Law Michelle J. White1,2 1Department