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Near-sighted Justice

Authors

  • DAN BERNHARDT,

  • ED NOSAL

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    • Bernhardt is with the Department of Economics, University of Illinois at Urbana-Champaign. Nosal is with the Federal Reserve Bank of Cleveland. The authors are grateful to the SSHRC for financial support. Much of the initial work was done when Nosal was visiting the Department of Economics at the National University of Singapore and when Bernhardt was at Queen's University in Canada. We both appreciate the research environments provided. We thank a referee, the editor, Ron Giammarino, Burton Hollifield, Charlie Kahn, and Steeve Mongrain for helpful comments. All errors are ours. The views expressed here do not necessarily represent the views of the Federal Reserve Bank of Cleveland or the Board of Governors of the Federal Reserve System.


ABSTRACT

Chapter 11 structures complex negotiations between creditors and debtors that are overseen by a bankruptcy court. We identify conditions where the court should sometimes err in determining which firms should be liquidated. Such errors affect actions by both good and bad entrepreneurs. We first characterize the optimal error rate without renegotiation. When creditors and debtors can renegotiate to circumvent an error-riven court, for one class of actions a blind court that ignores all information is optimal. For another class, the court should place the burden of proof on the entrepreneur. The robust feature is that the court should sometimes err.

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