The first nice aspect of this idea is that it immediately eliminates a great deal of uncertainty that would otherwise cloud the bankruptcy process. The laws that must be followed are clear, based on whatever nation's rules the firm decides to adhere to. This is especially good for investors, who can take this new variable into account when determining which firm's debt is most attractive at a given yield.
That clarity provides something extremely important for economic stability: speed. Without different countries bickering over which laws should be followed, proceedings should occur much more quickly. The market can then interpret the implications of the firm's bankruptcy faster and more forward.
Fits With Current Reform Plans
In fact, the debtor selection concept could also fit in well with Washington's work thus far on attempting to create a non-bank resolution authority. Doing so would include firms developing failure plans to facilitate the bankruptcy process. Wallison explains that a part of that plan should include which nation's laws a firm's resolution should follow:
In addition, if financial institutions are ultimately required to prepare some form of living will--a description of how they will be resolved in the event of insolvency--certainty about the applicable bankruptcy regime would be of great assistance in determining in advance how a resolution would proceed.
This matters a lot, because there's some worry that big firms will have a great deal of trouble determining how to fail if being pulled in different directions by conflicting bankruptcy laws from the different nations where it does business.
The Market Mostly Regulates Itself
One criticism of debtor selection might be that firms could intentionally choose rules with some end in mind, like preserving more power for management instead of creditors in bankruptcy. Yet, so long as creditors are aware of the debtor's selection, why would that matter? They can build that into the price they demand to purchase the firm's debt. Less favorable terms for creditors will require firms to pay up for their borrowing.
The same applies to the resolution authority's fund used to wind down firms. If the rules a firm wants to follow during failure would result in a more costly process, then the assessments on that firm would be greater than on a firm that chooses a less costly regime.
Should Apply to All -- Not Just Large -- Firms
Wallison makes an important point arguing that this proposal should apply to all firms:
A key question is whether the system should be limited to financial firms that are "systemically important." There is no need for this limitation. Indeed, no one has any idea when a company is systemically important or what factors might make it so.
Whether large firms would derive some competitive advantage from living under a different set of resolution rules than smaller firms has been discussed here. Wallison's point is even more general -- it's probably impossible to determine which firms are going to turn out to be systemically significant anyway. We might as well have the same rules across-the-board.