Debt, Equity, and Hybrid Decoupling: Governance and Systemic Risk Implications

Abstract

We extend here our prior work, which focused on equity decoupling (Hu and Black, 2006, 2007, 2008), by providing a systematic treatment of debt decoupling and an initial exploration of hybrid decoupling. Equity decoupling involves unbundling of economic, voting, and sometimes other rights customarily associated with shares, often in ways that may permit avoidance of disclosure and other obligations. We discuss a new U.S. court decision which will likely curtail the use of equity decoupling strategies to avoid large shareholder disclosure rules. Debt decoupling involving the unbundling of the economic rights, contractual control rights, and legal and other rights normally associated with debt, through credit derivatives and securitization. Corporations can have empty and hidden creditors, just as they can have empty and hidden shareholders. "Hybrid decoupling" across standard equity and debt categories is also possible. All forms of decoupling appear to be increasingly common. Debt decoupling can pose risks at the firm level for what can be termed "debt governance" -- the overall relationship between creditor and debtor, including creditors' exercise of contractual and legal rights with respect to firms and other borrowers. Widespread debt decoupling can also involve externalities and therefore create systemic financial risks; we explore those risks.

For our related work on equity decoupling, see:

Henry T. C. Hu & Bernard Black, Equity and Debt Decoupling and Empty Voting II: Importance and Extensions, 156 University of Pennsylvania Law Review 625-739 (2008), http://ssrn.com/abstract=1030721

Henry T. C. Hu & Bernard Black, Hedge Funds, Insiders, and the Decoupling of Economic and Voting Ownership: Empty Voting and Hidden (Morphable) Ownership, 13 Journal of Corporate Finance 343-367 (2007) (finance version of Hu and Black, 2006) (nearly final version), http://ssrn.com/abstract=874098

Henry T. C. Hu & Bernard Black, The New Vote Buying: Empty Voting and Hidden (Morphable) Ownership, 79 Southern California Law Review 811-908 (2006), http://ssrn.com/abstract=904004

Keywords: equity decoupling, debt decoupling, hybrid decoupling, empty voting, hidden ownership, equity swaps, credit default swaps, CDOs, disclosure, Securities and Exchange Commission, securitization, systemic risk

JEL Classification: G18, G32, G34, K22