Workouts, court-supervised reorganization and the choice between private and public debt

International audienceThis paper investigates the interaction between creditor structure and reorganization law. Private debt offers the advantage of flexible renegotiation out of court. Due to incomplete information and holdout incentives, the out-of-court renegotiation will typically fail for dispersed public debt. The introduction of Chapter 11-style renegotiation will benefit public debt firms and will be harmful for private debt firms. Moreover, Chapter 11 reduces the role of private debt in corporate borrowing in accordance with the US experience. The overall efficiency of a reorganization law is therefore ambiguous. Three prominent shortcomings of Chapter 11--its cost and delay, equity deviations and inefficient continuation--are shown to do little harm or even shown to be welfare-improving as they increase the incentives to renegotiate debt out of court and choose private debt. The effect of a low-cost reorganization procedure is more likely to be positive in a market-based financial system