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Article

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"Vacuum of Fact Or Vacuous Theory: A Reply to Professor Kripke," 133 Pennsylvania Law Review, 987 (1985) (with Thomas Jackson)

Abstract

In 1979, Thomas Jackson and Anthony Kronman asked the related questions why debtors offered security in personal property and whether a security interest would increase the welfare of a debtor and all of its creditors, taken as a group. These questions inspired a vigorous debate. The participants have taken as their starting point the Modigliani & Miller irrelevance proposition that if capital markets are perfect, information is perfect, all actors have homogeneous expectations, bankruptcy costs are zero, and no taxes exist, a firm cannot increase its value by altering its capital structure. A change in the mix of a firm's debt, from unsecured debt to secured, is an alteration in its capital structure. Since such a change cannot increase the firm's value and since it is costly for firms to offer security, the irrelevance proposition predicts that no secured debt will be issued. Because secured debt is common, participants in the "security interest debate" therefore proceed in two ways: they relax the strong assumptions that Modigliani & Miller made to see whether the new models thereby obtained predict security, or they add additional factors-moral hazard, risk aversion, and the like-to see whether models so derived can explain the observed data. All but one of the debaters claim to have found at least a tentative explanation for the existence of secured debt. Although the details of these explanations differ, they have a common theme: security- the debaters claim, exists and is justified because it is efficient; that is, a debtor can compensate those of its creditors whose position is worsened by security while remaining better off than had it not granted a security interest. Alan Schwartz, on the other hand, argues that no good explanations for the presence of security exist. Thus, he believes, claims of its efficiency are premature.

Date of Authorship for this Version

1985

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