Credit Default Swaps and Cost Management

41 Pages Posted: 6 Sep 2017 Last revised: 21 Nov 2017

See all articles by Jing Dai

Jing Dai

CUNY Baruch College

Rong Huang

City University of New York (CUNY) - Stan Ross Department of Accountancy

Yan Yan

Fairleigh Dickinson University

Date Written: November 20, 2017

Abstract

In this paper, we examine the effect of credit defaults swap (CDS) initiation on reference firms’ cost management behavior. CDS contracts provide insurance protection for lenders, inducing a shift in bargaining power from borrowers to lenders and an excessive incidence of bankruptcy. Anticipating more intransigent lenders in debt renegotiations and higher bankruptcy risk, borrowers are more concerned about liquidity and have heightened incentive to decrease cost stickiness after CDS initiation, as cost stickiness lowers liquidity and triggers early covenant violations. Consistent with our expectations, we find that CDS initiation is associated with a decline in reference firms’ cost stickiness. This association is more pronounced for (1) financially constrained firms; (2) firms with weaker bank relationships; and (3) firms with more financial covenants in debt outstanding. Collectively, our findings suggest that the CDS-induced “empty creditor problem” causes reference firms to be excessively concerned about liquidity and covenant violation, thus reducing the effectiveness of cost stickiness as a rational resource management tool.

Keywords: credit default swaps, empty creditors, cost stickiness, cost management

JEL Classification: G21, M40, M41

Suggested Citation

Dai, Jing and Huang, Rong and Yan, Yan, Credit Default Swaps and Cost Management (November 20, 2017). Available at SSRN: https://ssrn.com/abstract=3031534 or http://dx.doi.org/10.2139/ssrn.3031534

Jing Dai

CUNY Baruch College ( email )

17 Lexington Avenue
New York, NY 10021
United States

Rong Huang (Contact Author)

City University of New York (CUNY) - Stan Ross Department of Accountancy ( email )

One Bernard Baruch Way, Box B12-225
New York, NY 10010
United States
(646)312-3204 (Phone)

Yan Yan

Fairleigh Dickinson University ( email )

1000 River Rd
Teaneck, NJ 07666
United States

Register to save articles to
your library

Register

Paper statistics

Downloads
83
rank
291,853
Abstract Views
598
PlumX Metrics