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Second, the magnitude of the effect of a partial priority rule on the financing of projects will depend on the degree to which the rule continues to respect priority. Suppose that under our current ad hoc system of partial priority, secured claims are paid, on average, 90 cents on the dollar. If that is the case, replacing the current system with a 90% fixed-fraction priority rule is likely to have little effect on the financing of business activity, for better or for worse. A partial priority rule of 50% would, of course, have a larger effect, and so on.
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Third, even if a partial priority rule’s net effect on the financing of projects is undesirable (e.g., the economic cost arising from the failure of good projects to be financed is greater than the economic benefit arising from the failure of bad projects to be financed), the overall economic effect of partial priority may still be desirable because partial priority will provide other benefits that could offset the negative net effect on project financing. In particular, a partial priority rule might reduce the excessive use of security interests, lead to better monitoring of firms that do receive financing, and give firms more incentive to avoid externalizing harms on third parties. Thus, even if one believes that a particular partial priority rule’s net effect on financing projects is negative, one should still be open-minded as to whether the rule is worth adopting.

Some Preliminary Points

To begin, we want to make some general points on the cost and availability of credit under partial priority. Our claim is that, on an aggregate basis, the availability and cost of credit need not change substantially under a rule of partial priority.

This post was written by , posted on January 26, 2015 Monday at 4:37 pm