You Blinked: The Role and Incentives of Managers in Increasing Corporate Risks Following the Inception of Credit Default Swap Trade

Prior studies show that a lender’s incentive to monitor a client’s activities declines after receiving insurance on its loan via a credit default swap (CDS). We examine whether this altered debtor-creditor relation affects borrowers’ investment activities. We hypothesize that the borrower enhances activities that were previously constrained by lender monitoring. It shifts from safe to risky assets to increase the value of call options built into shareholder investments. We do not find support, on average, for this proposition. However, when managers’ wealth increases convexly with firm assets, borrowers increase risky investments and dividend payouts after the onset of CDS trading.

Keywords: Credit default swap (CDS), Agency conflict, Managerial compensation, Operating risks, Investment policy

JEL Classification: G32, G33, M41, M48

Suggested Citation: Suggested Citation

Hong, Hyun A. and Ryou, Jiwoo and Srivastava, Anup, You Blinked: The Role and Incentives of Managers in Increasing Corporate Risks Following the Inception of Credit Default Swap Trade (March 12, 2017). 2017 Canadian Academic Accounting Association (CAAA) Annual Conference, Available at SSRN: https://ssrn.com/abstract=2898987 or http://dx.doi.org/10.2139/ssrn.2898987