Asset-Backed Securities: Costs and Benefits of 'Bankruptcy Remoteness'

Once a tool used almost exclusively by banks, asset-backed securities (ABS) are increasingly becoming an important part of the capital structure decisions of both financial and non-financial firms. Yet, little formal analysis exists on this unique financial innovation from a corporate finance perspective. In this paper, we focus on a key property of these contracts; namely, that ABS are designed to achieve "bankruptcy remoteness" of the securitized assets from the borrowing firm. This provides lenders with protection from dilution in bankruptcy that is not available with other contractual forms, such as secured debt. Rather than simply shifting value from other creditors, as some scholars have suggested, ABS can have real effects in allowing firms to commit to more efficient investment decisions in bankruptcy. We show that securitization of replaceable assets, such as accounts receivable, is particularly valuable in preventing inefficient continuation in bankruptcy. With respect to necessary assets, however, ABS gives creditors hold-up power that can lead to inefficient liquidations. In these circumstances, secured debt and/or leases can be preferred because they provide efficiency-enhancing limits on creditor rights. Our model compares and contrasts these instruments and generates empirical predictions about their usage based on their respective treatment in Chapter 11. Our results are also relevant to the existing debate regarding regulatory treatment of securitization.