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

See all articles by Hyun A. Hong

Hyun A. Hong

University of California, Riverside (UCR) - A. Gary Anderson Graduate School of Management

Ji Woo Ryou

West Virginia University

Anup Srivastava

University of Calgary - Haskayne School of Business

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Date Written: March 12, 2017

Abstract

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

Hong, Hyun A. and Ryou, Ji Woo 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

Hyun A. Hong

University of California, Riverside (UCR) - A. Gary Anderson Graduate School of Management ( email )

Riverside, CA 92521
United States

Ji Woo Ryou

West Virginia University ( email )

PO Box 6025
Morgantown, WV 26506
United States

Anup Srivastava (Contact Author)

University of Calgary - Haskayne School of Business ( email )

2500 University Drive, NW
Calgary, Alberta T2N 1N4
Canada

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