This excellent Article by business school professors Sandeep Dahiya and Korok Ray provides a mathematical framework as an analytical tool to assist bankruptcy judges when confronting a Debtor-in-Possession financing situation. The U.S. Bankruptcy Code provides enhanced priority and security features to debtor-in-possession (DIP) loans which can be obtained from a lender with whom the borrower may have no past lending relationship. The enhanced priority of DIP financing, and the choice of a DIP lender, significantly affect the investment decisions made by the firm. This Article shows that DIP loans from an existing lender leads to a higher level of investment. The authors also show that a higher priority of DIP financing also leads to higher investment by the firm. A bankruptcy judge should take these incentives into account when approving the DIP loan. The authors conclude with extensive mathematical models to assist judges and firms in evaluating DIP loan decisions
