The Myth of Creditor Sabotage

58 Pages Posted: 18 Oct 2019

See all articles by Vincent S.J. Buccola

Vincent S.J. Buccola

University of Pennsylvania - The Wharton School - Legal Studies & Business Ethics Department

Jameson K. Mah

affiliation not provided to SSRN

Tai Yi Zhang

affiliation not provided to SSRN

Date Written: October 8, 2019

Abstract

Since credit derivatives began to substantially influence financial markets a decade ago, rumors have circulated about so-called “net-short” creditors who seek to damage promising albeit financially distressed companies. A recent episode pitting the hedge fund Aurelius against broadband provider Windstream is widely supposed to be a case in point and has at once fueled calls for law reform and yielded an ostensible effigy of Wall Street predation.

This article argues that creditor sabotage is a myth. Net-short strategies work, if at all, by in effect burning money. When therefore an activist creditor shows its cards, as all activists must eventually do, it also reveals an opportunity for others to profit by thwarting the activist’s plans and saving threatened surplus from the ashes. We discuss three sources of liquidity that targeted firms could tap to block a saboteur — “net-long” derivatives speculators, the targets’ own investors, and bankruptcy. We conclude that it is exceedingly difficult for creditors to make money hobbling debtors and that there is little reason to believe anyone tries. We then examine the Windstream case and find, consistent with our theory, that the strongest reason for thinking Aurelius aimed at sabotage, namely that everyone says so, is weak indeed. Our analysis suggests that calls for law reform are addressed to a non-existent or at worst self-correcting problem. Precisely for this reason, however, the persistent appeal of the sabotage myth is a lesson in political rhetoric. A story needn’t be true for some to find it useful.

Keywords: CDS, credit derivatives, creditor activism, net-short creditors, hedge fund activism, corporate law, corporate governance, bankruptcy

JEL Classification: G33, K22

Suggested Citation

Buccola, Vincent S.J. and Mah, Jameson K. and Zhang, Tai Yi, The Myth of Creditor Sabotage (October 8, 2019). University of Chicago Law Review, Forthcoming. Available at SSRN: https://ssrn.com/abstract=3466275

Vincent S.J. Buccola (Contact Author)

University of Pennsylvania - The Wharton School - Legal Studies & Business Ethics Department ( email )

3730 Walnut Street
Suite 600
Philadelphia, PA 19104-6365
United States

HOME PAGE: http://lgst.wharton.upenn.edu/profile/buccola/

Jameson K. Mah

affiliation not provided to SSRN

Tai Yi Zhang

affiliation not provided to SSRN

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