Bankruptcy decision making

When a firm encounters financial distress, there is a significant possibili ty that, at some point, the firm itself should be shut down and its assets put to better use. But Chapter 11 and indeed all market-mimicking reorganiz ation regimes other than a speedy auction entrust the shutdown decision to a bankruptcy judge who lacks information and expertise, as well as the abil ity to control the timing of her decisions, Understanding the costs of entr usting the shutdown decision to a bankruptcy judge is central to assessing any law of corporate reorganizations. This article models the shutdown deci sion as the exercise of a real option. The model suggests that the shutdown decision may loom so large in the early parts of the bankruptcy case that it erases any significant difference between Chapter 11 and many alternativ e market-mimicking regimes, All these regimes take more time than mandatory auctions and thus increase the cost of taking the shutdown decision away f rom a market actor. Moreover, the real option itself gives parties an incen tive to withhold information. Only a system of mandatory auctions both limi ts the amount of time the shutdown option resides with an inexpert decision maker and forces insiders to give that decision maker sufficient informati on to value the option while it is in her hands.