Lawyers: Gatekeepers of the Sovereign Debt Market?
60 Pages Posted: 21 Nov 2012
Date Written: November 18, 2012
The claim that lawyers act as gatekeepers or certifiers in financial transactions is widely discussed in the legal literature. There has, however, been little empirical examination of the claim. In this article, we test the hypothesis that law firms have replaced investment banks as the gatekeepers of the market for sovereign debt. We document a sea change in the relationship between issuers and investment banks on the one hand, and the relationship between issuers and outside law firms on the other. Prior to World War II outside law firms had little to no involvement in the issuance of sovereign debt. However, since World War II, and particularly since the late 1970s, the relationships between issuers and outside law firms have strengthened and their relationships with investment bankers have waned. In examining this sea change we find that issuers that hire only outside counsel to work with an investment banker pay a higher cost of capital than issuers who hire no outside counsel. We interpret this result as evidence that hiring an outside counsel is a sign of weakness on the part of the issuing sovereign. Moreover, we find that if the issuing sovereign hires two outside law firms – one to work with the underwriter and one that monitors the negotiations with the underwriter – the issuer’s cost of capital is higher than if it hires only an underwriter counsel. These results suggest that hiring outside law firms sends a negative signal to the market regarding the pending issue; a story inconsistent with the thesis that outside law firms play a certification role in the sovereign debt market.
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