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.218 Thus, if a debtor (D) granted a security interest in its assets inorder to obtain financing from a secured party (SP), other firm investors inparticular, shareholders and unsecured creditors should charge more, reflectingthe increased risks associated with the security interest.Whatever D might savein reduced interest costs charged by SP should be at least offset by an increasedrate of interest charged by unsecured creditors.Firm value and in particular, thecost of capital to the firm would not vary by virtue of the use of securedfinancing.The persistence of secured lending puzzled economically-oriented writersbecause, although secured transactions were (and are) far from costless to engagein, they should produce an economic wash internally, and may create greatersocial costs through negative externalities.This is because, among other reasons,many creditors unsophisticated trade creditors, tort creditors, terminatedemployees, taxing authorities, etc cannot in fact charge higher rates of interest.Having not chosen to extend credit, these non-adjusting creditors could notpublished law review articles.See Fred R.Shapiro, The Most-Cited Law Review Articles Revisited,71 CHI.-KENT L.REV.751, 759 (1996) (indicating that Coase's article was cited almost twice asoften as the next-most-cited law-related article).Coase had earlier suggested the contours of theproblem of social cost in R.H.Coase, The Federal Communications Commission, 2 J.L.& ECON.1, 33 (1959)).217Thomas H.Jackson & Anthony T.Kronman, Secured Financing and Priorities AmongCreditors, 88 YALE L.J.1143 (1979).218Modigliano & Miller, supra note [].Cf.David Gray Carlson, On the Efficiency of SecuredLending, 80 VA.L.REV.2179, 2219 (1994)(economic analysis of secured lending emanates froma peculiar misunderstanding of the famous Modigliani-Miller model. ).According toCarlson, [t]he Modigliani-Miller model died in 1976, when Michael Jensen and WilliamMeckling pointed out that Modigliani and Miller assumed that corporate structure never changesdebtor behavior. Id.(citing Michael C.Jensen & William H.Meckling, Theory of the Firm:Managerial Behavior, Agency Costs and Ownership Structure, 3 J.FIN.ECON.305, 332-33(1976)).Jensen and Meckling identified the problem of agency cost the cost imposed by the riskthat X will act, wittingly or not, to the disadvantage of Y.Jensen and Meckling, supra.Carlsonwrites as if proponents of the economic approach were ignorant of the contribution of Jensen andMeckling.It is, however, clear that its earliest proponents Jackson and Kronman wellunderstood their contribution, and the more general problem of agency costs.See Jackson &Kronman, supra note [] at 1149 1161.While the Modigliani-Miller theory may have many flaws, it remains an important tool inconceptualizing the microeconomics of firm of organization.Professor Schwarcz, for example,purports to have solved the puzzle of secured lending, given certain assumptions, usingModigliani & Miller.Steven L.Schwarcz, The Easy Case for the Priority of Secured Claims inBankruptcy, 47 DUKE L.J.425, 429 (1997).C:\inetpub wwwroot\results\4381-text.native.1091721321.doc; 8/5/2004 11:50 AM\http://law.bepress.com/expresso/eps/314 ExpressO Preprint SeriesThe End of Notice Page 45 of 74charge correspondingly higher rates of interest (or otherwise protect themselvesfrom loss of recourse to the debtor s assets).219 Thus, while a secured creditorwould have access to all of a debtor s property, those in the most vulnerableposition would not.This would, in turn, create perverse managerial incentives todisregard risks thus externalized.220 The debtor that gave full priority in its assetsto a particular secured creditor would have externalized all losses onto those in221the worst position to protect themselves.Since the transaction costs associatedwith secured lending were presumed greater than the transaction costs associatedwith other methods of financing many academics followed the lead of Jacksonand Kronman in asking why rational market actors would engage in suchtransactions.Asking and answer the questions posed by the Modigliani-Millerpuzzle, as writ small in commercial finance law, became an enormously attractiveenterprise for legal academics.222219The term nonadjusting creditors is generally associated with Bebchuk and Fried, who use itin Lucian Arye Bebchuk & Jesse M.Fried, The Uneasy Case for the Priority of Secured Claims inBankruptcy, 105 YALE L.J.857, 864 (1996).Bebchuk and Fried take the term one step further,and apply it to all creditors for whom adjustment may either be costly or implausible, such assmall-dollar trade creditors, or creditors who extended unsecured credit before the debtor grantedthe security interest.220Bebchuk & Fried supra note [], at 934 (arguing that the rule of full priority causes excessiveuse of security interests, reduces the incentive of firms to take adequate precautions and chooseappropriate investments, and distorts the monitoring arrangements chosen by firms and theircreditors ).Other contributions to this body of literature are collected in Lipson, Remote Control,supra note 120, at 1403, n.403.221As Bebchuk and Fried explained The fact that security interests may be used to transfer value from nonadjusting creditorsunder a full-priority rule means that security interests may be used even when they give rise toinefficiencies.As our analysis will demonstrate, the ability to use security interests to divertvalue from nonadjusting creditors tends to distort the borrower's choice of contractualarrangements with its creditors, giving rise to certain efficiency costs.Bebchuk & Fried, supra note [], at 965.There have been a number of responses which develop reasonably plausible claims that securedlending under certain circumstances can be efficient.See, e.g., David Gray Carlson, On theEfficiency of Secured Lending, 80 VA.L.REV.2179, 2219 (1994); Homer Kripke, Law andEconomics: Measuring the Economic Efficiency of Commercial Law in a Vacuum of Fact, 133 U.PA.L.REV.929 (1985); Schwarcz, Easy Case, supra note []; Paul M [ Pobierz całość w formacie PDF ]
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.218 Thus, if a debtor (D) granted a security interest in its assets inorder to obtain financing from a secured party (SP), other firm investors inparticular, shareholders and unsecured creditors should charge more, reflectingthe increased risks associated with the security interest.Whatever D might savein reduced interest costs charged by SP should be at least offset by an increasedrate of interest charged by unsecured creditors.Firm value and in particular, thecost of capital to the firm would not vary by virtue of the use of securedfinancing.The persistence of secured lending puzzled economically-oriented writersbecause, although secured transactions were (and are) far from costless to engagein, they should produce an economic wash internally, and may create greatersocial costs through negative externalities.This is because, among other reasons,many creditors unsophisticated trade creditors, tort creditors, terminatedemployees, taxing authorities, etc cannot in fact charge higher rates of interest.Having not chosen to extend credit, these non-adjusting creditors could notpublished law review articles.See Fred R.Shapiro, The Most-Cited Law Review Articles Revisited,71 CHI.-KENT L.REV.751, 759 (1996) (indicating that Coase's article was cited almost twice asoften as the next-most-cited law-related article).Coase had earlier suggested the contours of theproblem of social cost in R.H.Coase, The Federal Communications Commission, 2 J.L.& ECON.1, 33 (1959)).217Thomas H.Jackson & Anthony T.Kronman, Secured Financing and Priorities AmongCreditors, 88 YALE L.J.1143 (1979).218Modigliano & Miller, supra note [].Cf.David Gray Carlson, On the Efficiency of SecuredLending, 80 VA.L.REV.2179, 2219 (1994)(economic analysis of secured lending emanates froma peculiar misunderstanding of the famous Modigliani-Miller model. ).According toCarlson, [t]he Modigliani-Miller model died in 1976, when Michael Jensen and WilliamMeckling pointed out that Modigliani and Miller assumed that corporate structure never changesdebtor behavior. Id.(citing Michael C.Jensen & William H.Meckling, Theory of the Firm:Managerial Behavior, Agency Costs and Ownership Structure, 3 J.FIN.ECON.305, 332-33(1976)).Jensen and Meckling identified the problem of agency cost the cost imposed by the riskthat X will act, wittingly or not, to the disadvantage of Y.Jensen and Meckling, supra.Carlsonwrites as if proponents of the economic approach were ignorant of the contribution of Jensen andMeckling.It is, however, clear that its earliest proponents Jackson and Kronman wellunderstood their contribution, and the more general problem of agency costs.See Jackson &Kronman, supra note [] at 1149 1161.While the Modigliani-Miller theory may have many flaws, it remains an important tool inconceptualizing the microeconomics of firm of organization.Professor Schwarcz, for example,purports to have solved the puzzle of secured lending, given certain assumptions, usingModigliani & Miller.Steven L.Schwarcz, The Easy Case for the Priority of Secured Claims inBankruptcy, 47 DUKE L.J.425, 429 (1997).C:\inetpub wwwroot\results\4381-text.native.1091721321.doc; 8/5/2004 11:50 AM\http://law.bepress.com/expresso/eps/314 ExpressO Preprint SeriesThe End of Notice Page 45 of 74charge correspondingly higher rates of interest (or otherwise protect themselvesfrom loss of recourse to the debtor s assets).219 Thus, while a secured creditorwould have access to all of a debtor s property, those in the most vulnerableposition would not.This would, in turn, create perverse managerial incentives todisregard risks thus externalized.220 The debtor that gave full priority in its assetsto a particular secured creditor would have externalized all losses onto those in221the worst position to protect themselves.Since the transaction costs associatedwith secured lending were presumed greater than the transaction costs associatedwith other methods of financing many academics followed the lead of Jacksonand Kronman in asking why rational market actors would engage in suchtransactions.Asking and answer the questions posed by the Modigliani-Millerpuzzle, as writ small in commercial finance law, became an enormously attractiveenterprise for legal academics.222219The term nonadjusting creditors is generally associated with Bebchuk and Fried, who use itin Lucian Arye Bebchuk & Jesse M.Fried, The Uneasy Case for the Priority of Secured Claims inBankruptcy, 105 YALE L.J.857, 864 (1996).Bebchuk and Fried take the term one step further,and apply it to all creditors for whom adjustment may either be costly or implausible, such assmall-dollar trade creditors, or creditors who extended unsecured credit before the debtor grantedthe security interest.220Bebchuk & Fried supra note [], at 934 (arguing that the rule of full priority causes excessiveuse of security interests, reduces the incentive of firms to take adequate precautions and chooseappropriate investments, and distorts the monitoring arrangements chosen by firms and theircreditors ).Other contributions to this body of literature are collected in Lipson, Remote Control,supra note 120, at 1403, n.403.221As Bebchuk and Fried explained The fact that security interests may be used to transfer value from nonadjusting creditorsunder a full-priority rule means that security interests may be used even when they give rise toinefficiencies.As our analysis will demonstrate, the ability to use security interests to divertvalue from nonadjusting creditors tends to distort the borrower's choice of contractualarrangements with its creditors, giving rise to certain efficiency costs.Bebchuk & Fried, supra note [], at 965.There have been a number of responses which develop reasonably plausible claims that securedlending under certain circumstances can be efficient.See, e.g., David Gray Carlson, On theEfficiency of Secured Lending, 80 VA.L.REV.2179, 2219 (1994); Homer Kripke, Law andEconomics: Measuring the Economic Efficiency of Commercial Law in a Vacuum of Fact, 133 U.PA.L.REV.929 (1985); Schwarcz, Easy Case, supra note []; Paul M [ Pobierz całość w formacie PDF ]