6 research outputs found
Managers\u27 Fiduciary Duty Upon the Firm\u27s Insolvency: Accounting for Performance Creditors
A corporation\u27s managers generally owe a fiduciary duty to the corporation and its shareholders. Legal scholars interpret this duty as requiring the managers to maximize shareholder value. When a firm is solvent, the obligation to maximize shareholder value tends to give managers an incentive to deploy firm assets efficiently-that is, in a way that maximizes total value.
When a firm is insolvent, however, the duty to maximize shareholder value could lead managers to take actions that reduce the value of debt more than they increase the value of equity and therefore reduce total value. Accordingly, a number of courts have held that upon a firm\u27s insolvency, managers owe a fiduciary duty not only to shareholders but also to creditors.
The courts have yet to clearly articulate how managers of an insolvent firm should balance the interests of shareholders against those of creditors. However, economically oriented legal scholars addressing this issue have argued that managers of an insolvent firm should have a duty to maximize the sum of the values of all financial claims (both those held by shareholders and those held by creditors) against the firm. Put differently, an insolvent firm\u27s managers should maximize the total financial value of the firm, not just the value of its equity. We call this view the financial value maximization ( FVM ) approach
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Managers' Fiduciary Duty Upon the Firm's Insolvency: Accounting for Performance Creditors
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Managers' Fiduciary Duty Upon the Firm's Insolvency: Accounting for Performance Creditors
Corporate managers generally owe a fiduciary duty exclusively to shareholders --a duty interpreted as requiring the managers to maximize shareholder value. When the firm is solvent, the duty to maximize shareholder value tends to give managers an incentive to act efficiently that is, in a way that increases total value. But when the firm is insolvent, this duty might give managers an incentive to run the firm in a way that reduces the value of debt more than it increases the value of equity and, therefore, is inefficient. The leading view among corporate law scholars is that an insolvent firm's managers should therefore maximize the sum of the values of all financial claims both those held by shareholders and those held by creditors against the firm. This Article points out a previously unrecognized problem with this "financial value maximization" ("FVM") approach. What FVM proponents have overlooked is that an insolvent firm is likely to have two types of creditors: (1) "'payment creditors" parties owed cash, who hold financial claims against the firm; and (2) "performance creditors" parties owed contractual performance, who hold claims for performance against the firm. The FVM approach requires managers to take into account the effect of their actions on one type of creditor payment creditors but not on the other performance creditors. We show that FVM's failure to account for performance creditors might cause an insolvent firm's managers to act in a way that harms performance creditors more than it benefits those with financial claims against the firm and, therefore, is inefficient. Our analysis indicates that an insolvent firm's managers should be obligated to maximize the sum of the values of all claims against the firm, both claims for cash and claims for performance. This approach, we show, would eliminate the distortions associated with the FVM approach and actually make shareholders better off ex ante