The chapters in this book are the result of a project designed to explore opportunities for interdisciplinary research in international and comparative law, particularly research employing theoretical or empirical economics. The project reflects our conviction that economic analysis of law has much to contribute to the study of international matters, but that to date mainstream international legal scholars and scholars interested in economic methods have had lamentably little interaction.

The chapters address a range of issues, including international trade, trade and the environment, law and development, the political economy of privatization and exchange rate policies, economic theories of international institutional design, immigration policy, comparative bankruptcy, international antitrust, and extraterritorial jurisdiction. Dean Ronald Cass of Boston University Law School has generously contributed an overview discussing the broader interaction between economics and international law. He also discusses in detail a number of the chapters in this volume.

Each of the chapters was presented at a conference in the spring of 1995, sponsored by Duquesne University and George Mason University. Accordingly, some of the chapters are followed by comments and criticisms from conference participants.

This project would not have been possible without the support of Duquesne University and George Mason University and their respective law school deans, Nicholas P. Cafardi and Henry G. Manne. Lori Godshall of Duquesne University has provided tireless secretarial and logistical assistance throughout the process of preparing the papers and the final manuscript.

Although bankruptcy law is apparently designed to address the problems of creditors too dispersed to negotiate effectively for disposition of an insolvent firm's assets, settlement impediments can exist even if all important creditors can get together and negotiate face to face. Even with a limited number of creditors, one or more creditors may behave strategically, threatening to exercise destructive individual collection rights unless other creditors make concessions. The two chapters in the part, Stuart Gilson, “Managing Defaults: Some Evidence on How Firms Choose Between Workouts and Bankruptcy,” and John McConnell and Henri Servaes, “The Economics of Prepackaged Bankruptcy,” explain how creditors can use the bankruptcy process to impose a negotiated settlement on potential holdouts. Such use of the bankruptcy process would be expedited as compared to the imbroglios described by previous selection in the book.

Moreover, as Gilson and McConnell and Servaes illustrate, workouts, whether or not enforced by a “prepackaged” bankruptcy case, will reflect bankruptcy law entitlements, but need not lead to all the inefficiencies described by prior chapters.

This book has been a long time in process. It was apparent to most observers some years ago that economic analysis of law had matured. Law and economics scholars produced a multitude of papers that found their way into existing and newly begun journals. Readers or edited volumes appeared in various areas of the law such as torts, contracts, antitrust administrative law, and corporate law. For various reasons, economic analysis of bankruptcy law was somewhat slower in developing. This may appear puzzling, at first, in view of the fact that many issues in bankruptcy intimately implicate financial or economic considerations. Perhaps, the slower application of economic methods or analyses to bankruptcy law partly can be ascribed to the fact that most scholars of bankruptcy law in the late 1970s and early 1980s were not yet tutored in economic thinking. And, in any case,the bankruptcy law underwent a major revision in 1978. Consequently, some time elapsed before experience accumulated with the new law and before scholars of bankruptcy law mastered the tools of both theoretical and quantitative economics.

The last decade has witnessed a very rapid growth in scholarship employing economic reasoning and methods to various issues in bankruptcy law and a large body of such literature now exists in the form of articles and even case-books. However, to our knowledge, there is, as of yet, no existing reader or convenient collection of articles in this area, analogous to the many edited volumes in other areas of the law.

A corporation finances its operations (working capital and long-term assets) by issuing a combination of equity and credit. A firm may compensate suppliers of equity capital with dividends and, eventually, with proceeds from the firm's liquidation. The right to either, however, is residual and subject to any creditor claims. The only noncontingent right of an equity investor is the right to vote on matters of concern to the firm; most importantly, the right to elect the firm's managers. In contrast to its relationship with equity investors, a firm agrees to compensate creditors with fixed payments. A creditor's right to payment generally is noncontingent and, in the event a firm defaults on a fixed obligation, the unpaid creditor may begin collection proceedings pursuant to applicable nonbankruptcy law.

In a world without bankruptcy law, a collecting creditor might seize assets critical to the corporation's operation. A bankruptcy petition temporarily halts all legal proceedings against the debtor corporation and provides a period of time, or breathing space, for the corporation to renegotiate its fixed obligations. The nature and propriety of this breathing space is the subject of much of the literature on bankruptcy. However, the logical starting point for a book on corporate bankruptcy is an explanation of debt itself, because without debt's fixed obligations there would be no threat of destructive collection and no firm would need bankruptcy protection.

The first chapter in the book is the Nobel Memorial Prize Lecture “Leverage” by Merton Miller. In this lecture Miller uses recent concern about leveraged buyouts in the United States to explain the inherent advantages of fixed obligations to a firm – advantages that go beyond any benefits that result from United States income tax laws.

Despite the arguable benefits from breaches in absolute priority described by the chapters in Part III and the possibility of private workouts or expedited bankruptcy proceedings described by the chapters in Part IV, the bankruptcy reorganization process is costly for many firms. A number of chapters in Part II provide details about those costs. This part explores the possibility that alternatives to bankruptcy can provide investors with the benefits from the bankruptcy process without the costs that this process imposes on at least some firms.

The first five chapters in this part explore the idea that market valuations can simplify the insolvency process. If the market established a value for an insolvent firm's assets, many of the disputed issues in a bankruptcy reorganization would disappear. In the simplest case, a bankruptcy court could auction an insolvent firm for cash, then distribute the cash to claimants in accordance with the claimants' contractual priorities. The purchaser and not the court would have the problem of restructuring the firm's finances. And the court would not have to decide the value of the property it distributed; there can be no debate over the value of cash. With this theme of simplification in mind Michael Jensen, “Corporate Control and the Politics of Finance,” Douglas G. Baird, “The Uneasy Case for Corporate Reorganizations,” Mark J. Roe, “Bankruptcy and Debt: A New Model for Corporate Reorganization,” and Lucian A. Bebchuk “A New Approach to Corporate Reorganizations” offer various schemes to value an insolvent firm through the sale or distribution of unvalued interests in a bankrupt firm.

The chapters included in Part I explain why some firms include debt in their capital structures and others prefer to have debt with heterogeneous levels of priority. The chapters in this part explain the problems debt financing creates and the role of bankruptcy law in addressing those problems.

To understand the problems created by debt financing, imagine a firm that manufactures copper wire at a time when technology dictates that fiber optics will replace most uses of copper wire. The advent of fiber optics makes obsolete much of the manufacturers equipment and requires that the manufacturer substantially retool if it is to stay in business.

This obsolescence and the prospect of retooling significantly reduces the value of the firm compared to its value prior to the introduction of new technology. Such a reduction in value would not precipitate a financial crisis if the firm were financed purely by equity. The equity owners directly or through the firm managers acting as equity agents would simply assess the viability of the firm in the new world of fiber optics. The shareholders or their agents would then decide whether to continue the firm or to wind it up. If the firm continued, it would use existing capital or raise new capital to retool. If the firm wound up, it would liquidate and divide its assets ratably among the shareholders. In either case, the process could be orderly.

Nothing in the basic creditors' bargain heuristic requires that bankruptcy law alter the contractual priorities among claimants to a firm's assets. Indeed several of the chapters included in Part II explore how bankruptcy law can provide a collective proceeding while honoring contractual priorities. Yet bankruptcy's collective process routinely breaches contractual – or “absolute” priority – in that bankrupt firms distribute assets to equity interests though the firms are insolvent and distribute assets to general, low-priority creditors without fully satisfying high-priority claims. These breaches in absolute priority are partly a direct consequence of rules that favor redistribution, and largely a consequence of bankruptcy's expensive negotiation procedures, which induce high-priority claimants to make concessions in return for settlement and termination of the costly process. The chapters in this part explore in more detail how the bankruptcy process alters contractual priorities.

The first chapter is Douglas G. Baird and Thomas H. Jackson, “Bargaining after the fall and the contours of the absolute priority rule.” In this chapter, Baird and Jackson explore the bankruptcy negotiation process among highpriority creditors, low-priority creditors, and equity. They note that this negotiation process may produce breaches in absolute priority if one focuses solely on the outcome. But, Baird and Jackson explain, one must be aware of the possibility that the outcome is a product of a hypothetical distribution consistent with absolute priority followed by creditors' concession to equity as consideration for equity's continued participation in the firm.

Professors Bhandari and Weiss have put together a splendid anthology on the economics of corporate bankruptcy. A subject that lies at the intersections of price theory and game theory and of economic theory and finance theory – a subject moreover of great practical importance because of the large number of bankruptcies of major business firms in recent years – it has attracted some of the keenest minds in law, economics, and their interface have generated a literature of great power and variety well illustrated by the selections in this volume.

The literature has a twofold focus. The first is the puzzle of corporate debt. Without debt, and indeed without multiple creditors, a corporation would not face a substantial risk of bankruptcy (there would be some risk, because of the possibility of multiple involuntary creditors, such as asbestos tort claimants). Since bankruptcy is usually a personal disaster for the managers of the bankrupt firm, and since according to the Modigliani–Miller thesis the value of a firm is invariant to its capital structure, one is surprised that American corporations typically have so much debt and so many creditors. The answer is that the thesis abstracts from what may be important aspects of the economics of corporate structure, not only the obvious one – the more favorable tax treatment of debt than of equity – but also agency costs. Among other things, corporate debt may offset excessive risk aversion by managers that is due to the fact that their wealth is concentrated in firm-specific human capital.

The final chapters of the book examine bankruptcy laws in other countries and provide a comparison to United States law.

The first chapter of this part, Julian Franks' and Walter Torous', "Lessons from a Comparison of U.S. and U.K. Insolvency Codes," favorably compares British to American insolvency law. British law, Franks and Torous observe, better respects creditor priority and thus provides for a less costly transition of control from equity to an insolvent firm's new residual claimants, the creditors.

The next chapter is Michelle White's, "The Costs of Corporate Bankruptcy." White offers a broad comparison among U.S., U.K., French, and German bankruptcy laws and concludes that there is no easy way to identify the best approach. She notes the costs of regimes, such as that in the United States, under which management controls an insolvent firm throughout a reorganization process. These costs are chronicled throughout the chapters in this book. However, White adds, there are other costs to alternative regimes that make bankruptcy less attractive to management. These costs include waste from management's attempt to avoid bankruptcy at any cost. Any cost may be a high cost.

The next chapter, Theodore Eisenberg's and Schoichi Tagashira's, "Should We Abolish Chapter 11? The Evidence from Japan," derives lessons from Japanese insolvency law. Eisenberg and Tagashira note that there are potential efficiency gains from differentiating the treatment of large and small firms in bankruptcy, a differentiation that is often discussed, but that does not now exist, in the United States. For example, Eisenberg and Tagashira argue that auctions may be appropriate only for large firms.