Some friends and I got into talking about bankruptcy law after taking a class on finance. First of all, we were pretty shocked at the way the incentive system works these days. Our prof showed us this binomial model of pricing (ie, businesses have a good year or a bad year) and proved that it was in the shareholders' best interest to maximize risk. That means that smart moves like JetBlue and Southwest hedging their bets with oil futures would have been opposed by shareholders, and in the case of Southwest, the shareholders were actually quite angry that this was done.

The binomial model he presented actually expands out into a more robust model known as Black-Scholes options pricing, and it yields the same results: maximize risk. That means that all of these corporate goliaths are running around teetering on the edge of bankruptcy and loving it. In fact, mayn of them probably want to go bankrupt so they can unload those pesky pension plans (USAir for instance).

In the end, what I take away from this is that bankruptcy laws have a huge effect on how corporations act. And as I see it, there is no obviously or definitively correct way to structure bankruptcy. Currently the system holds that liabilities (pensions, bonds, etc.) are to be paid with the corporations remaining money, and any money owed after that is defaulted on. This leads essentially to a liability black hole. If you look at liability as a good (albeit one with negative value), then what you have here is ill-defined property rights, which results in intrinsic efficiency losses.

One solution I could conceive of is actually going to the shareholders and asking them for the extra money to pay the liabilities, since they own the corporation after all. Naturally, you would make them pay in proportion to the fraction of the company they own. This would actually open the shareholders up to a potentially unbounded loss, but it would certainly make people more weary about what kinds of corporations they invested in. People would be very preferential to stable companies with sound business plans. Not only that, they would love companies that followed the laws and didn't get involved in shady deals.

In general equilibrium, individual investors may end up opting for mutual funds or holding funds in order to sheild them from risk, or they could buy bankruptcy insurance for a particular stock. These mutual funds would have a massive interest in keeping the companies in line, and could certainly be trusted to enforce, since there seem to be ecomies of scale in that area.

And there you have it, the issue of corporate liability is solved. Maybe it's a pipe dream. Maybe someone has to work out a model to see if it'll work. But it sounds real good to me.

"And they call me an assasin. What do you call it when the assasins accuse the assasin? They lie... they lie and we have to be merciful for those who lie."