Do Banks Still Monitor When There Is a Market for Credit Protection?
Journal of Accounting and Economics, Forthcoming
62 Pages Posted: 2 Nov 2018 Last revised: 17 Jul 2019
Date Written: February 27, 2019
The rise of credit default swaps (CDS) provides creditors with a market-based approach to obtaining protection, but it can also affect lenders’ monitoring of the borrowers. We find that after CDS begin trading on a given firm, new loans to that firm are less likely to require collateral and have less strict financial covenants, even controlling for endogeneity. The effects are stronger when lenders have easier access to CDS, for safer firms, credit lines, and performance-based covenants. Our evidence is consistent with the theory that the introduction of CDS trading makes loan contracting more effective for better quality borrowers.
Keywords: Credit default swaps, CDS, Collateral, Covenants
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