Financial contracts and the legal treatment of informed investors

Mitchell Berlin and Loretta Mester

No 99-8, Working Papers from Federal Reserve Bank of Philadelphia

Abstract: The authors explore the economic rationale for equitable subordination, a legal doctrine that permits a firm's claimants to seek to subordinate an informed investor's financial claim in bankruptcy court. Fear of equitable subordination is often cited as a reason that banks in the U.S. are wary of taking an active management role in their borrowing firms. The authors show that an optimally designed menu of claims for a large investor will include features that resemble equitable subordination. The authors' model provides a partial rationale for a financial system in which powerful creditors do not generally hold blended debt and equity claims.

Keywords: Bankruptcy (search for similar items in EconPapers)
Date: 1999
New Economics Papers: this item is included in nep-cfn, nep-fin and nep-ind
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