In a liq where you normally auction off all the assets, its simple - the assets are reduced to cash, the creditors get paid and if paid in full whatever is left goes to shareholders. In a reorg, esp. one that occurred because of too much debt load (sometimes bk happens for reasons other than debt like long term fixed price contracts or leases etc), the debt must be converted to equity upon exit - otherwise the company would just land right back in bk a year later. In order to do this, an enterprise value for the company has to be agreed to by the parties. Just like with appraising a house, there is a range and one number needs to be picked at the end - but unlike a house there are many more moving parts. So lets take an example of a company with 500 in debt that cannot be paid with cash because there isn't enough and cannot remain as debt because the company still wouldn't be fixed. When they go to value the company, if it gets valued at 400 - then debt holders get the whole thing. If it gets valued at 600, then debtholders get 83% and shareholders keep 17%. Now obviously, from the debtholders view, this number is the difference between getting it all, and getting something less than all, so they have every incentive to push for a low number - to argue about the discount rates and the profit assumptions, and they usually play a big role in picking the investment bank that performs the appraisal, and the investment bank knows this and knows they wont' get picked again if they don't deliver a number that makes these hedge funds happy. The debtors mgmt also plays a role, but since the creditors are always careful to throw them 10% of the new shares IF they cooperate, mgmt is usually in cahoots with the creditors. So its a largely rigged system - never a question of who gets the fairer side of the coin, but a question of how extreme will the bias against shareholders be. To make an example - say Kmart was truly worth 100 when it exited (the true measure is probably close to where it got 6 months to 1 year after). Creditors are owed 75. If they value it correctly, then creditors get stock worth 75 and equity gets 25. But if you rig the valuation to show 50 - and these things are so complicated its not that difficult - then creditors get stock stated to be worth 50 but its really worth 100, and they don't have to hold on too long after emergence to sell with a 25 mm profit - when as creditors they were really just supposed to get their principal/interest back.
