The costs and benefits of secured creditor control in bankruptcy: Evidence from the UK

Recent theoretical literature has debated the desirability of permitting debtors to contract with lenders over control rights in bankruptcy. Proponents point to the monitoring benefits brought from concentrating control rights in the hands of a single lender. Detractors point to the costs imposed on other creditors by a senior claimant's inadequate incentives to maximise net recoveries. The UK provides the setting for a natural experiment regarding these theories. Until recently, UK bankruptcy law permitted firms to give complete ex post control to secured creditors, through a procedure known as Receivership. Receivership was replaced in 2003 by a new procedure, Administration, which was intended to introduce greater accountability to unsecured creditors to the governance of bankrupt firms, through a combination of voting rights and fiduciary duties. We present empirical findings from a hand-coded sample of 348 bankruptcies from both before and after the change in the law, supplemented with qualitative interview data. We find robust evidence that whilst gross realisations have increased following the change in the law, these have tended to be eaten up by concomitantly increased bankruptcy costs. The net result has been that creditor recoveries have remained unchanged. This implies that dispersed and concentrated creditor governance in bankruptcy may be functionally equivalent.