You Blinked: The Role and Incentives of Managers in Increasing Corporate Risks Following the Inception of Credit Default Swap Trade
65 Pages Posted: 14 Jan 2017 Last revised: 24 May 2017
Date Written: March 12, 2017
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