Placing innovative assets in a separate subsidiary creates more autonomy for the unit manager of the innovation than a division, even when the subsidiary is wholly owned and controlled by the parent. The key driver is limited liability: unlike a division, the parent has the option to walk away from the subsidiary’s debt obligations. As a result, the parent invests less in developing internal uses for the innovation. This causes the unit manager to invest more in developing independent uses for the innovation: he must ”sink or swim” on his own effort, and his desired actions are less subject to overrule. Received June 29, 2012; editorial decision June 8, 2016 by Editor Paolo Fulghieri.

[This article focuses on a key property of asset-backed securities (ABS); namely, that ABS are designed to achieve "bankruptcy remoteness" of securitized assets from the borrowing firm. This provides lenders with protection from dilution that is not available with contracts such as secured debt. ABS allows firms to commit to more efficient investment decisions in bankruptcy. Securitization of replaceable assets (such as receivables) prevents inefficient continuation, but securitization of necessary assets can produce ex-post inefficiency, which favors secured debt. We test a prediction of our model using the LTV Steel bankruptcy, in which bankruptcy remoteness was successfully challenged. We find that ABS spreads for Chapter 11—eligible securitizers increased significantly more than spreads for Chapter 11—ineligible securitizers following LTV.]

[This article adopts a definition of property rights from legal scholarship: A property right (in contrast to a contractual right) is enforceable, not only against the parties to a contract, but also against third parties outside the contract. In a financial contracting setting, we ask: When should the law enforce a lender's contractual protections as property rights, given that these rights may be hidden and costly for other lenders to discover? Our model explains why the law limits the creation and enforceability of property rights, and develops principles of optimal enforceability. These principles are often reflected in the law.]

This article focuses on a key property of asset-backed securities (ABS); namely, that ABS are designed to achieve “bankruptcy remoteness” of securitized assets from the borrowing firm. This provides lenders with protection from dilution that is not available with contracts such as secured debt. ABS allows firms to commit to more efficient investment decisions in bankruptcy. Securitization of replaceable assets (such as receivables) prevents inefficient continuation, but securitization of necessary assets can produce ex-post inefficiency, which favors secured debt. We test a prediction of our model using the LTV Steel bankruptcy, in which bankruptcy remoteness was successfully challenged. We find that ABS spreads for Chapter 11–eligible securitizers increased significantly more than spreads for Chapter 11–ineligible securitizers following LTV.

This article adopts a definition of property rights from legal scholarship: A property right (in contrast to a contractual right) is enforceable, not only against the parties to a contract, but also against third parties outside the contract. In a financial contracting setting, we ask: When should the law enforce a lender's contractual protections as property rights, given that these rights may be hidden and costly for other lenders to discover? Our model explains why the law limits the creation and enforceability of property rights, and develops principles of optimal enforceability. These principles are often reflected in the law.