Renegotiation Frictions and Financial Distress Resolution: Evidence from CDS Spreads

Abstract

This paper examines how the relaxation of renegotiation frictions impacts distressed debt resolution and ex-ante financial contracting. It does so exploiting a recent IRS regulation (TD9599) that reduced the taxes certain creditors owe upon restructuring debt out of court. CDS contracts insure creditors against in-court bankruptcy losses and CDS spreads reflect the shadow price of bankruptcy risk. Using a triple-differences estimation framework, we show that CDS spreads fell by record figures on the regulation's announcement, with declines concentrated among distressed firms that relied most on syndicated loans---the credit category treated by TD9599. Distressed firms' loan renegotiation rates more than doubled, as banks agreed to extend loan maturities in exchange for higher interest payments. Those firms' access to new syndicated loans increased while associated interest markups declined after TD9599.

Keywords: Loan renegotiation, taxes, bankruptcy, credit default swaps, credit access.

JEL Classification: G32, G33