DO SENIORITY PROVISIONS PROTECT BONDHOLDERS INVESTMENTS

Several studies have documented that violations of the absolute priority rule are commonplace, and that the lowest-priority claimants benefit from violations. This study investigates the efficiency of the market for bonds of firms that default and subsequently file for Chapter 11. While the results suggest that bonds are overpriced at the time of default, the results are generally supportive of efficiency. The authors also document the losses bankrupt firms' bondholders experience over the entire life of the bond. They find that bonds with seniority provisions receive significantly higher payoffs at emergence than subordinated bonds, providing indirect evidence that the bonds are efficiently priced at issuance.