Abstract

The canonical theory of bankruptcy law is that it solves a market failure by imposing a collective choice process that supplants the market. We propose that a bankruptcy law instead catalyzes the market if the collective choice process offers scope for rent seeking. Based on a model in which coordination failures are the key friction, as in the canonical theory, we argue that such a law induces activist investing which improves

the efficiency of distressed restructuring. We interpret the evolution of Chapter 11 and its surrounding market environment through this lens.