Credit Default Swaps and Lender Incentives in Bank Debt Renegotiations

Using a regression-discontinuity design and within lender-borrower variation, we analyze how Credit Default Swaps (CDS) affect bank incentives and borrower outcomes in renegotiations after covenant violations. While existing studies document an investment decline after covenant violations, we find that covenant-violating firms maintain their investment subsequent to the introduction of CDS trading. Moreover, after CDS introduction, covenant-violating firms are less likely to default. Our results suggest that in the private debt markets, CDS discipline borrowers, while the empty creditor problem due to CDS is mitigated because of lenders' reputation concerns and lower coordination frictions.

Keywords: Credit Default Swaps, Bank Lending, Empty Creditor Problem, Moral Hazard.

JEL Classification: G21, G31, G32

Suggested Citation: Suggested Citation

Chakraborty, Indraneel and Chava, Sudheer and Ganduri, Rohan, Credit Default Swaps and Lender Incentives in Bank Debt Renegotiations (February 23, 2022). Georgia Tech Scheller College of Business Research Paper No. 2015-20, Available at SSRN: https://ssrn.com/abstract=2541102 or http://dx.doi.org/10.2139/ssrn.2541102