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Absolute Priority Rule Violations in Bankruptcy

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Violations of the absolute priority rule in both private workouts and Chapter 11 reorganizations have been enigmatic for financial economists. Why do such violations exist? Do they promote or curtail economic efficiency? This paper demonstrates that the answers depend on the specific contracting problem that a firm and its creditors face. As a result, an optimal bankruptcy institution should allow contract participants to decide ex ante whether such violations will occur.


Suggested citation: Longhofer, Stanley D., and Charles T. Carlstrom. “Absolute Priority Rule Violations in Bankruptcy,” Federal Reserve Bank of Cleveland, Economic Review, vol. 31, no. 4, pp. 21-30, 12.01.1995.

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