Jamesian Philosophy Refreshed

There was a fascinating discussion of the "absolute priority rule" in bankruptcy, in Dealbook , on December 6th. Yes, this will bring us to William James but, I warn you, there's some expository material to get through first. The APR says that in any bankruptcy of a corporate entity, the secured creditors get paid in full before unsecured creditors get a dime, and the unsecured creditors in turn get paid in full before the equity holders get their own first dime. Under the existing code, there are three ways to bring a chapter 11 case to an end: turn it into a chapter 7 liquidation; confirm a plan; or dismiss it. The first two must comply with the APR. A dismissal doesn't have to comply with APR because, after all, why should it? It's a dismissal! But "dismissals" are not always mere dismissals, returning everything to the pre-filing status quo. No, certain agreed-upon arrangements have long been acceptable under the name "structured dismi...

I remember taking a Corporate Finance course in law school. I retained a few things therefrom, for example, a sense of the sharp legal distinction between the rights of debtors on the one hand and the rights of owners of equity on the other. There was some material too about friendly versus unfriendly takeovers, and the ways in which the latter might be resisted by the target company's board. But what I remember most vividly about the course was a discussion of the Miller-Modigliani theorem. This is the hypothesis proposed by the two named economists, Merton H. Miller and Franco Modigliani, that a rational corporate management will be indifferent as to whether it raises money by issuing debt or by issuing new stock. The debt/equity distinction, as important as it was in law, was trivial in economics. Or so the economists said. [ Investopedia contains a fine article explaining the basics.]  I was very struck by this M/M theorem, and not just be...