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Rev Fin 1997; 10:1203-1236
© 1997 the Society for Financial Studies

Article

Why is bank debt senior? A theory of asymmetry and claim priority based on influence costs

I Welch
Anderson Graduate School of Management at UCLA, 110 Westwood Plaza (C4.16), Los Angeles, CA 9095-1481, USA. E-mail: ivo.welch@anderson.ucla.edu

Abstract

This theory can explain why bank debt is universally senior, consistent with the presence of conflict (lawyers) and absolute priority violations in financial distress: Better organized banks would more strongly contest priority in financial distress if they were junior. Because 'deterrence' can reduce creditors' total expenses in a priority contest, the ex post stronger lobbyist/litigant should be senior ex ante. For equivalent reasons, the theory can advise when public debt should be senior to trade credit and/or implicit contrasts, and can even suggest one rationale for the absolute priority rule (APR). This article further shows that Chapter 11 creditor reimbursement procedures can lower overall costs.


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