Public Policy toward Bankruptcy: Me-First and Other Priority Rules

This article analyzes the economic efficiency properties of bankruptcy liquidation rules, including both conventional legal rules and the me-first rule proposed by economists. It also examines the incentives of firms to undertake investment projects when bankruptcy is a possible outcome. The results show that none of the rules leads to private investment incentives which are socially efficient. Depending on circumstances, it may be privately profitable to liquidate firms which should be continued or to continue firms which should be liquidated. Investments in low productivity projects may be approved while worthwhile projects may be abandoned. Public policy implications are considered.