No Exit? Withdrawal Rights and the Law of Corporate Reorganizations

Bankruptcy scholarship is largely a debate about the comparative merits of a mandatory regime on one hand and bankruptcy by free design on the other. By the standard account, the current law of corporate reorganization is mandatory. Various rules that cannot be avoided ensure that investors’ actions are limited and they do not exercise their rights against specialized assets in a way that destroys the value of a business as a whole. These rules solve collective action problems and reduce the risk of bargaining failure. But there are costs to a mandatory regime. In particular, investors cannot design their rights to achieve optimal monitoring as they could in a system of bankruptcy by free design. This Article suggests that the academic debate has missed a fundamental feature of the law. Bankruptcy operates on legal entities, not on firms in the economic sense. For this reason, sophisticated investors do not face a mandatory regime at all. The ability of investors to place assets in separate entities gives them the ability to create specific withdrawal rights in the event the firm encounters financial distress. There is nothing mandatory about rules like the automatic stay when assets can be partitioned off into legal entities that are beyond the reach of the bankruptcy judge. Thus, by partitioning assets of one economic enterprise into different legal entities, investors can create a tailored bankruptcy regime. In this way, legal entities serve as building blocks that can be combined to create specific and varied but transparent investor withdrawal rights. This regime of tailored bankruptcy has been unrecognized and underappreciated and may be preferable to both mandatory and free design regimes. By allowing a limited number of investors to opt out of bankruptcy in a particular, discrete, and visible way, investors as a group may be able to both limit the risk of bargaining failure and at the same time enjoy the disciplining effect that a withdrawal right brings with it

The Roles of Standardization, Certification and Assurance Services in Global Commerce

In this article we examine the rapid emergence and expansion of standardized product and process frameworks and a private-sector compliance and enforcement infrastructure that we believe may increasingly be providing a substitute for public and legal regulatory infrastructure in global commerce. This infrastructure is provided by a proliferation of performance codes and standards, many of which define acceptable social and environmental behavior, and a rapidly-growing number of privately-trained and authorized inspectors and certifiers that we call the third-party assurance industry. We offer reasons for this development, evidence of its scope and scale, and then describe the phenomenon in more detail by examining supply chain arrangements in two industries, food products and apparel, where the use of third-party standards and assurance services has expanded especially rapidly. We conclude with a discussion of the implications for the make or buy decision at the core of the theory of the firm. We argue that as quasi-regulatory standards are developed within various industries, and as performance to these standards can be systematically evaluated using third-party inspectors and certifiers, the costs of moving production outside of vertical firm hierarchies drop. We believe this may be an important factor in accelerating the shift to outsourcing that has been observed over the last two decades