How Do Lenders Monitor? A Discussion of Shan, Tang, and Winton (2019)

Abstract

Credit default swaps (CDS) represent a major innovation in debt markets, allowing lenders to transfer credit risk to a counterparty by paying a premium. Shan, Tang, and Winton (2019) explore whether the availability of CDS affects the monitoring incentives of lenders. Their paper finds that CDS leads to looser loan terms (less collateral and looser covenants), consistent with a reduction in monitoring incentives. I examine several aspects of their study, including whether loan provisions and CDS should serve the same purpose, and differences between CDS and non-CDS borrowers. In total, although the authors present empirical evidence consistent with their prediction, the sample selection and research design potentially limit the generalizability of the authors’ results.

Keywords: CDS, debt covenants, debt contracting

JEL Classification: G23, G32, M41