Information and Priority Rules

Bankruptcy and corporate laws in several countries allow or require courts to subordinate loans by shareholders to corporations. Examples include the equitable subordination and recharacterization doctrines in the US and the German Eigenkapitalersatzrecht. Scholars have not devoted much attention to these rules so far despite their rather unclear economic implications. We propose a model that focuses on the role of information and ex-ante investment incentives. We find that informational asymmetries can justify the requalification: The more priority is given to the uninformed creditor, the better are the results from a welfare perspective.