Document Type


Publication Date



Center for Contract and Economic Organization


Program in the Law and Economics of Capital Markets


The debate over the social value of secured credit (and the appropriate priority for secured claims in bankruptcy) is entering its nineteenth year. Yet the continuing publication of succeeding generations of articles exploring the topic have yielded precious little in the way of an emerging scholarly consensus about the nature and function of secured credit.1 Put simply, we still do not have a theory, of finance that explains why firms sometimes (but not always) issue secured debt rather than unsecured debt or equity. Moreover (and perhaps because of the lack of any plausible general theory), we lack any persuasive empirical data to predict whether, in any particular case, a later security-financed project will generate sufficient returns to offset any reduction in the value (i.e., the bankruptcy share) of prior unsecured claims.

The security debate has generated more heat than light because the opposing sides have divided primarily along methodological rather than normative lines. As a result, each side has generally failed to learn from, and adjust to, the legitimate insights offered by the other. But although we have much to learn, there is much about secured financing that we already know. In this Article, I build upon the existing scholarship and seek to answer three questions. First, what are the right (and the wrong) questions to ask if we are to advance our understanding of secured credit and its appropriate priority? Second, what do we know (and not know) about the answers to any of these questions? Third, what normative stance is justified in a world of uncertainty in which may of the key questions are unlikely to be answered for some time (if ever)?

Before I proceed, however, one needs first to separate and classify the participants in this debate. The division, perhaps predictably, is between those who believe that truth comes from the top down (the theorists) and those that believe that truth is built from the bottom up (the empiricists or contextualists). These categories are quite broad, however. Some of those who begin with theory have sought to test their claims against available evidence, while some of those whose beliefs are shaped by experience and context have sought to critique the theory on its own terms. In neither case, however, have these forays into the other domain been very successful. Moreover, because the divide is methodological, the participants rarely join issue on particular normative claims. Some theorists are skeptical about the efficiency claims of secured credit, while others have sought to fashion positive theories that purport to explain some (or all) of the patterns of financing that we observe. On the other side, a common hostility toward (or skepticism about) economic theory joins together those who passionately defend the institution of secured credit as a major contributor to social welfare with those who seek to restrict the priority granted to secured interests in bankruptcy. The end product of this strange conversation has been a tendency to recycle old ideas and old criticism and to pay more attention to the methodological warfare than the search for truth. In the process, the few genuine insights that the debate has generated-both empirical and theoretical-have largely been overlooked.