A Theory of Corporate Insolvency

Modern scholarship on corporate bankruptcy works from the premise that investors are willing to expend resources identifying and saving insolvent firms that can continue efficiently. In this Article, Professor Adler argues that this premise may be faulty, at least for multiple-creditor firms. Viewed properly, from an ex ante perspective, investors may wish to design initial capital structures that will produce few insolvent but viable firms. Consequently, in a world of unimpeded contractual choice investors might forgo any collective insolvency process directed primarily at the preservation of going concerns. Professor Adler argues, accordingly, that corporate bankruptcy law and proposals for its replacement may be ill-advised for largefirms, not because these firms could efficiently continue post insolvency without bankruptcy reorganization or some substitute, but because it may be appropriate that these firms not continue. In the process of making this argument, Professor Adler offers new interpretations of three puzzling phenomena: asset-based finance; the failure of investors to contractually avoid the seemingly expensive American bankruptcy reorganization process; and common equity’s residual interest in a firm that fails to pay dividends on preferred stock.