Shareholder Opportunism in a World of Risky Debt

63 Pages Posted: 27 Apr 2009 Last revised: 17 Feb 2010

See all articles by Richard Squire

Richard Squire

Fordham University School of Law; European Corporate Governance Institute (ECGI)

Date Written: April 25, 2009


Modern finance is increasingly dominated by derivatives and similar contracts that create contingent debts, which become payable only upon the occurrence of an uncertain future event. This Article identifies a pervasive opportunism hazard created by contingent debt that lawmakers and scholars have overlooked. If liability on a firm’s contingent debt is especially likely to be triggered when the firm is insolvent, the contract that creates the debt transfers wealth from the firm’s creditors to its shareholders. A firm therefore has incentive to engage in correlation-seeking — that is, to incur contingent debts that correlate, or that through asset purchases can be made to correlate, with the firm’s insolvency risk. The consequence is an overuse of contingent debt that destroys social wealth through overinvestment, higher borrowing costs, financial distress, and potential systemic risk. Correlation-seeking is especially pernicious because, unlike other forms of shareholder opportunism such as asset substitution, it can reduce risk to shareholders even as it increases shareholder returns. Conduct that is consistent with correlation-seeking played a central role in the 2008 financial crisis, causing the deep losses suffered by the three firms to receive the biggest bailouts: AIG, Fannie Mae, and Freddie Mac. Yet current and proposed legal rules for derivatives and other contingent debt contracts ignore matters of correlation, increasing the risk of another financial crash in the future.

Keywords: derivatives, credit default swap, correlation, bankruptcy, guaranty, fraudulent conveyance

JEL Classification: K22, G13, G20

Suggested Citation

Squire, Richard C., Shareholder Opportunism in a World of Risky Debt (April 25, 2009). Harvard Law Review, Vol. 123, 2010, Available at SSRN:

Richard C. Squire (Contact Author)

Fordham University School of Law ( email )

150 West 62nd Street
New York, NY 10023
United States
212-964-1584 (Phone)

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels

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