What is an ‘Absolute Priority’
An absolute priority is a rule that stipulates the order of payment – creditors before shareholders – in the event of liquidation. The absolute priority rule is used in bankruptcies to decide what portion of payment will be received by which participants. Debts to creditors will be paid first and shareholders (partial owners) divide what remains.
Explaining ‘Absolute Priority’
Absolute priority specifies the pecking order. Senior creditors always get first grabs at the proceeds from liquidation, and shareholders are the last to get paid. This rule provides a degree of protection to creditors in the event of insolvency or death. The division of benefits (cash) is not always the result of a bankruptcy. It can also occur due to the liquidation of assets in order to pay down a company’s liabilities.
Further Reading
- Ex ante costs of violating absolute priority in bankruptcy – onlinelibrary.wiley.com [PDF]
- Absolute priority rule violations and risk incentives for financially distressed firms – www.jstor.org [PDF]
- Management's incentives, equity's bargaining power, and deviations from absolute priority in Chapter 11 bankruptcies – www.jstor.org [PDF]
- Agency problems of debt, convertible securities, and deviations from absolute priority in bankruptcy – www.journals.uchicago.edu [PDF]
- The importance of deviations from the absolute priority rule in Chapter 11 bankruptcy proceedings – www.jstor.org [PDF]
- Absolute priority rule violations, credit rationing, and efficiency – www.sciencedirect.com [PDF]
- Pricing the risk of recovery in default with absolute priority rule violation – www.sciencedirect.com [PDF]
- Bankruptcy, absolute priority, and the pricing of risky debt claims – www.sciencedirect.com [PDF]
- Much ado about nothing: Absolute priority deviations in chapter 11 – www.jstor.org [PDF]
