The Dark Side of 2005 Bankruptcy Code Reform —Does Derivatives Privilege Affect Corporate Borrowing?

52 Pages Posted: 4 Sep 2017 Last revised: 20 Feb 2019

See all articles by Maggie Rong Hu

Maggie Rong Hu

Chinese University of Hong Kong

Chenyu Shan

Shanghai University of Finance and Economics

Margaret Rui Zhu

The Chinese University of Hong Kong (CUHK)

Date Written: February 17, 2019

Abstract

The 2005 Bankruptcy Reform puts derivatives contracts into an effective “super-senior” status. It is intended to provide stability to the derivative markets and reduce systemic risk, however, we find that it has negative impact on derivative-using firms’ borrowings. The theoretical model in Bolton and Oehmke (2015) suggests that the super-seniority status of derivatives shifts risk to the creditors and could lead to inefficiency in corporate borrowing. Using a unique set of hand-collected corporate derivatives-usage data, we examine the effects of 2005 Bankruptcy Reform on firms’ borrowing capacity and cost. We document that derivatives users are less likely to obtain loans from banks. Even if they do, the loans they obtain have smaller size, higher loan spread, and more stringent collateral requirements. The effects of derivatives usage on loan terms are more pronounced for firms closer to financial distress. Collectively, these findings shed light on the dark side of the 2005 Bankruptcy Reform and help the understanding of potential conflict of interest amongst various creditors in general.

Keywords: Derivatives privilege, Bankruptcy Reform, Debt contracting, Conflict of interest

JEL Classification: G32, G33, G38

Suggested Citation

Hu, Maggie Rong and Shan, Chenyu and Zhu, Margaret Rui, The Dark Side of 2005 Bankruptcy Code Reform —Does Derivatives Privilege Affect Corporate Borrowing? (February 17, 2019). Available at SSRN: https://ssrn.com/abstract=3031595 or http://dx.doi.org/10.2139/ssrn.3031595

Maggie Rong Hu

Chinese University of Hong Kong ( email )

Cheng Yu Tung Building
12 Chak Cheung Street
Hong Kong, N.T.
Hong Kong

Chenyu Shan

Shanghai University of Finance and Economics ( email )

100 Wudong Road
Shanghai
China

Margaret Rui Zhu (Contact Author)

The Chinese University of Hong Kong (CUHK) ( email )

Shatin, N.T.
Hong Kong
Hong Kong
+852 3943 3216 (Phone)

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