Should Derivatives Be Privileged in Bankruptcy?
Columbia Business School - Department of Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)
Columbia Business School - Finance and Economics
March 5, 2014
Journal of Finance, Forthcoming
Derivatives enjoy special status in bankruptcy: They are exempt from the automatic stay and effectively senior to virtually all other claims. We propose a corporate finance model to assess the effect of these exemptions on a firm's cost of borrowing and its incentives to engage in efficient derivative transactions. While derivatives are value-enhancing risk management tools, seniority for derivatives can lead to inefficiencies: It transfers credit risk to debtholders, even though this risk is borne more efficiently in the derivative market. Seniority for derivatives is efficient only if it provides sufficient cross-netting benefits to derivative counterparties that provide hedging services.
Number of Pages in PDF File: 58
Keywords: Derivatives, Swaps, Automatic Stay, Chapter 11, QFCs, Safe Harbors
JEL Classification: G30, G33
Date posted: March 16, 2012 ; Last revised: March 5, 2014
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