This paper extends Professor Margaret Blair and Lynn Stout's pathbreaking Team Production Theory of Corporate Law to the bankruptcy reorganization of public companies. The paper begins by describing the prevailing contractarian theory of bankruptcy reorganization, the Creditors' Bargain Theory propounded by Professor Thomas Jackson in 1982. The paper briefly describes the Team Production Theory of Corporate Law and then projects the consequences of that theory for the firm in bankruptcy. The final part of the paper compares the Team Production Theory of Bankruptcy Reorganization with the Creditors' Bargain theory, reaching two conclusions. First, the Team Production Theory of Bankruptcy Reorganization describes the bankruptcy system more accurately than does the Creditors' Bargain theory. Second, if the empirical assumptions underlying the Team Production Theory of Corporate Law theory are accurate, the ex ante maximization recommended by the Team Production Theory of Bankruptcy Reorganization will better serve the goal of economic efficiency than the ex post maximization recommended by the Creditors' Bargain theory.
[S]ociety must insist on the maintenance of the "going concern" and must if necessary sacrifice to it the individual rights of shareholders, creditors, workers, and, in the last analysis, even of consumers.
- Peter Drucker1
In the year before United Airlines filed for bankruptcy reorganization, the firm lost $3.2 billion.2 Fierce competition in the airline industry prevents United from stemming its losses solely through increases in revenues. Costs will have to be cut. The necessary expense reductions could come from reductions in employee pay and benefits, reductions in the amounts owing to creditors (which reduce interest expense), or both. Which should it be?
United's situation is complicated by the fact that its employees own 55 percent of its stock and that their wage levels are protected by a collective bargaining agreement.3 But if we assume those protections away, we reach a fundamental issue that has divided bankruptcy scholars for two decades: whose interests should bankruptcy reorganization serve?
The currently prevailing contractarian theories of the firm and of bankruptcy recommend cutting labor costs first. Bankruptcy, these theorists postulate, exists solely for the benefit of the creditors and shareholders of the firm. The theorists recognize that the interests of employees, suppliers, customers, and communities should be taken into account to the extent particular members of those constituencies are creditors with enforceable legal rights against assets under nonbankruptcy law. But they assert that to take any other interest of those constituencies into account would-as one writer put itconstitute "prima facie theft."4
The theorists' first premise derives from the agency theory of the firm. Shareholders own the firm. The board of directors, the managers, and the employees are the shareholders' agents, mere hired hands. When the firm is insolvent, ownership shifts to the creditors. In bankruptcy reorganization, the owners' interests, and theirs alone, are to be served. Debt, it follows, should be cut only as a last resortafter any possible cuts in labor costs.
Another group of bankruptcy scholars, sometimes referred to as "traditionalists," are of the less elegant view that bankruptcy exists to serve a variety of policies and therefore a variety of interests. Their answer to the hypothetical is that the losses should be shared among all interested parties, including creditors and shareholders. Because their arguments are noncontractarian and do not place economic efficiency first, they fall on deaf contractarian ears. The two groups talk past one another.5
In 1999, Professors Margaret Blair and Lynn Stout introduced a new and powerful contractarian theory of the public corporationone that only now is beginning to have its impact. …