Benefitsof Filing for Corporate Bankruptcy over Bailout
Benefitsof Filing for Corporate Bankruptcy over Bailout
When a firmencounters insurmountable fiscal challenges, it can file for abankruptcy where its businesses can be liquidated and debts orobligations discharged, which helps the firm to rearrange while itprovisionally suspends certain obligations. Bankruptcy means that afirm will continue to run daily operations while a trustee liquidatesthe firm’s assets to discharge all debts. It is imperative to notethat bankruptcy retains incentives as companies that make badinvestments bear the costs of doing so since bondholders andcreditors recover their losses. Thus, bankruptcy punishes individualswho took unwarranted risks and preserves the aspects of a firm thatremain unprofitable usually seen when certain obligations aretemporarily suspended, but daily operations of the firm continue.
The comprehensive and well-established processes in handlingbankruptcy allow easier management transition. Ayotte and Skeel(2010) in analyzing Drexel’s bankruptcy opine that the process doesnot necessarily takes long especially in resolving the financialchallenges of a firm. In 1990 at a period when people saw delay as ahuge shortcoming of Chapter 11, Drexel petitioned the courts forbankruptcy, which took 2 years to end, but assets were redeployedinstantly long before the subsequent restructuring. The firm managedto attain a limited restructuring in spite of the government’srepudiation to allow it recommence its business. Creditors got morethan 50% of what the company owed them, which means that bankruptcyis well designed to handle firms. Firms can acquire bankrupt firms acase supported by Barclay’s acquisition of Lehman, which allows afirm to operate under a different name.
On the other hand, bailouts involve rescuing an entity from actual orpotential insolvency. In most cases, governments bailout the entitiesstaring at possible insolvency, for example, the American governmentbailed out several firms during the 2008-09 crisis such as GM,Chrysler, and AIG. This means that firms can take imprudent risks,and if the risks are comprehended, wealth from taxpayers is allocatedto these firms. Ayotte and Skeel (2010) contend that researchers donot easily justify the partiality for bailouts as they create moralhazard and distort corporate governance of the affected businesses.In most cases, bailouts allocate a great amount of wealth to firmsthat knowledgeably engage in risky subprime lending, which means itencourages firms to engage in large and imprudent risks and count ongovernments bailing them. The moral hazard engenders greatmisrepresentations in an economy’s distribution of financialresources thus, governments repossess wealth from industriousindividuals of the economy and allocate it to failing individuals orfirms. When a government bailout these firms, it inhibits the assetsfrom being discharged and made accessible to firms that can use theassets productively.
References
Ayotte, K., &Skeel Jr, D. A. (2010). Bankruptcy or bailouts? Journal ofCorporate Law., 35(3), 469-498.