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
Date Written: February 17, 2019
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: Suggested Citation