Bankruptcy problem

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The bankruptcy problem,^[1] also called the claims problem,^[2] is the problem of distributing a homogeneous divisible good (such as money) among people with different claims. The focus is on the case where the amount is insufficient to satisfy all the claims.

The canonical application is a bankrupt firm that is to be liquidated. The firm owes different amounts of money to different creditors, but the total worth of the company's assets is smaller than its total debt. The problem is how to divide the scarce existing money among the creditors.

Another application would be the division of an estate amongst several heirs, particularly when the estate cannot meet all the deceased's commitments.

A third application^[2] is tax assessment. One can consider the claimants as taxpayers, the claims as the incomes, and the endowment as the total after-tax income. Determining the allocation of total after-tax income is equivalent to determining the allocation of tax payments.

Definitions

The amount available to divide is denoted by E (=Estate or Endowment). There are n claimants. Each claimant i has a claim denoted by c_i.

It is assumed that $\sum _{i=1}^{n}c_{i}\geq E$ , that is, the total claims are (weakly) larger than the estate.

There are at least three simple methods for solving bankruptcy problems in practice, but each is deficient in one or more ways. The methods are:^[1]

The proportional rule: divide the estate proportionally to each agent's claim. For example, if the estate is worth 100 and the claims are 60 and 90, then the first creditor gets 40 and the second creditor gets 60.
The constrained equal-awards rule: divide the estate equally among the agents, ensuring that nobody gets more than their claim.
The constrained equal-losses rule: divide equally the difference between the aggregate claim and the estate, ensuring that no agent ends up with a negative transfer.

Another rule, appearing already in the Babylonian Talmud, is the contested garment rule.^[3]

References

^ ^a ^b Alcalde, José; Peris, Josep E. (2017-02-17). "Equal Awards vs. Equal Losses in Bankruptcy Problems". SSRN.
^ ^a ^b "Axiomatic and game-theoretic analysis of bankruptcy and taxation problems: a survey". Mathematical Social Sciences. 45 (3): 249–297. 2003-07-01. doi:10.1016/S0165-4896(02)00070-7. ISSN 0165-4896.
^ Dagan, Nir (1996). "New characterizations of old bankruptcy rules". Social Choice and Welfare.

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