Financial Innovations and Corporate Insolvency

Abstract

In this paper we develop a theory of financial innovations within the field of corporate insolvency. The theory is motivated by the comparative histories of the US and the UK. In the empirical section we argue that the currently observed institutional differences across the two countries are historically determined. We show how they evolved out of different innovation regimes. UK law was innovated by lenders and borrowers exercising their freedom of contract, while US law was innovated by judges and legislators whose intervention, often, violated contractual agreements. In the theoretical section we develop a formal model that analyzes the potential advantages and disadvantages of the two innovation regimes. The freedom of contract regime preserves the ex ante outlook of the parties, but it is crude and under-refined. Legislative intervention produces more refined procedures, but runs the risk of being politically biased. Our analysis is much affected by the notion that corporate law is, essentially, a set of contractual standards. Key words: standard contracts, financial innovations, freedom of contract, floating charge, Chapter 11. 1 Financial Innovations and Corporate Insolvency 1.