Can the Market Evaluate Legal Regimes? A Response to Professors Rasmussen, Thomas, and Skeel

INTRODUCTION Scholarly projects benefit from thoughtful criticism-particularly by those committed to a contrary view. For that reason, I feel fortunate that the three leading proponents of the efficiency of Delaware bankruptcy reorganization have taken the time to respond to our study.1 These three critics recognize that the stakes are enormous. As Professor Rasmussen and Professor Thomas put it, the bankruptcy reorganization of large, public companies was "Delawarized" during the decade of the 19908.2 If it can be shown that, during the period of Delawarization, the Delaware court provided a wasteful and inefficient reorganization process, it follows that even a very sophisticated "market" can make huge errors, and that by the time the market realizes it has made a mistake in the choice of a legal regime, that regime may already be locked in by a network effect. That, in turn, would discredit the frequently made argument that a legal regime must have been efficient or the market would not have chosen it. 1. RASMUSSEN AND THOMAS' COMMENTS In our study of bankruptcy refiling rates, Sara Kalin and I found that the refiling rates for Delaware reorganizations were six to seven times as high as the refiling rates for reorganizations in courts other than Delaware and New York.3 Because the costs of each refiling are so high that we doubted they could be offset by possible advantages of Delaware reorganization not investigated, we concluded that the extraordinarily high failure rate that resulted from these reorganizations suggests a lack of efficiency, and we asserted in the title of our article that our empirical findings were "evidence of a `race to the bottom.'" Rasmussen and Thomas do not challenge our empirical findings,4 but, on essentially four bases, they do challenge our conclusion that the data constitute evidence of inefficiency. First, they argue that, with respect to prepackaged cases, Delaware's higher refiling rate may have occurred by chance. Second, using a mathematical model, they argue that the additional costs of Delaware's refilings could be offset by cost savings in the initial Delaware bankruptcy cases. Third, they observe that we have investigated only a few of the variables that, in combination, might account for Delaware's high refiling rate, and they argue that some variable not studied might yet absolve Delaware of responsibility for its apparent failure. Finally, they raise some methodological concerns. A. The Performance of Prepackaged Bankruptcies Prior to our study, Rasmussen and Thomas advanced the theory that Delaware's prepackaged bankruptcies must be efficient because they are contractual arrangements among all of the interested parties (the "Delaware prepack superiority theory").5 In our study, we found that: (1) Delaware bankruptcies were significantly more likely to result in refilings than were bankruptcies in other courts;6 (2) Delaware prepacks were considerably more likely to result in refilings than were prepacks in other courts;7 and (3) Delaware prepackaged cases were slightly more likely to lead to refilings than Delaware nonprepackaged cases.8 We discovered no category of cases with a worse refiling rate than the 33% refiling rate for Delaware prepacks. These findings seem to cast serious doubt on Rasmussen and Thomas' Delaware prepack superiority theory. In their comment on our study, Rasmussen and Thomas make clear that they are not yet ready to give up.9 Confident that their theory must be correct and that the data are somehow misleading, they turn first to the possibility that Delaware's high refiling rate for prepacks occurred by chance. The data are as follows: Applying Fisher's exact test to a comparison of the Delaware rate with the rate for other courts (excluding New York), Kalin and I measured the possibility of so great a difference occurring by chance at 7.4%.10 Rasmussen and Thomas do not question the accuracy of that measurement. …