Credit Default Swaps and Lender Incentives in Renegotiations of Bank Debt
65 Pages Posted: 21 Dec 2014 Last revised: 5 Mar 2020
Date Written: August 12, 2015
We analyze how Credit Default Swaps (CDS) affect bank incentives and borrower outcomes in renegotiations after covenant violations. Using a regression-discontinuity design and within lender-borrower variation, we find that CDS firms maintain investment after control rights shift to the creditor, whereas non-CDS firms experience a significant decline. Moreover, CDS firms are less likely to experience distressed exits or rating downgrades in the two years after these technical defaults. 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: Bank Loans, Disciplining Effect, Covenant Violation, Empty Creditor Problem
JEL Classification: G21, G31, G32
Suggested Citation: Suggested Citation