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Fairness in bankruptcy situations: an experimental study

Cappelen, Alexander W.; Luttens, Roland I.; Sørensen, Erik Ø.; Tungodden, Bertil
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URI
http://hdl.handle.net/11250/296604
Date
2015-08
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  • Discussion papers (SAM) [578]
Abstract
The pari passu principle is the most prominent principle in the law of insolvency.

We report from a lab experiment designed to study whether people

find this principle a fair solution to the bankruptcy problem. The experimental

design generates situations where participants work and accumulate

claims in firms, some of which subsequently go bankrupt. Third-party arbitrators

are randomly assigned to determine how the liquidation value of the

bankrupt firms should be distributed between claimants. Our main finding

is that there is a striking support for the pari passu principle of awarding

claimants proportionally to their pre-insolvency claims. We estimate a random

utility model that allows for the arbitrators to differ in what they consider

a fair solution to the bankruptcy problem and find that about 85 percent of the

participants endorse the proportional rule. We also find that a non-negligible

fraction of the arbitrators follow the constrained equal losses rule, while there

is almost no support in our experiment for the constrained equal awards rule

or other fairness rules suggested in the normative literature. Finally, we show

that the estimated random utility model nicely captures the observed arbitrator

behavior, in terms of both the overall distribution of awards and the

relationship between awards and claims.
Publisher
SAM
Series
Discussion paper;17/15

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