Credit Default Swaps and the Cost of Capital

77 Pages Posted: 24 Apr 2020 Last revised: 13 Oct 2020

See all articles by Harjeet Bhabra

Harjeet Bhabra

Saint Mary's University

Pascal Francois

HEC Montreal - Department of Finance

Thomas John Walker

Concordia University, Quebec - Department of Finance

Chunrong Wang

Concordia University

Date Written: March 31, 2020

Abstract

This study uses the universe of US public firms to examine the impact of credit default swap (CDS) trading on a firm’s cost of capital during the period 2001–2018. Our results robustly show that the inception of CDSs causes a significant reduction in a firm’s weighted average cost of capital (WACC). We also find an increase in the number of analysts who recommend buying CDS firms’ stocks post-CDS trading, suggesting an improvement in the firms’ information environment. Further analyses reveal that highly levered firms tend to reduce their debt weight, while firms with low leverage increase their usage of debt. In equilibrium, we find a marginally decreased net debt issuance post-CDS trading. Moreover, CDS referenced firms adjust their debt placement by using more arm-length debts, while they simultaneously decrease the usage of revolving credits and term loans from banks. The change in capital financing choices may be ascribed to the improved information environment and reflects the fact that CDS trading increases debt renegotiation costs and simultaneously reduces capital supply side frictions.

Keywords: Credit Default Swaps, Weighted Average Cost of Capital, Empty Creditors, Capital Structure, Public debt, Bank debt

JEL Classification: G23, G30, G32

Suggested Citation

Bhabra, Harjeet and Francois, Pascal and Walker, Thomas John and Wang, Chunrong, Credit Default Swaps and the Cost of Capital (March 31, 2020). Available at SSRN: https://ssrn.com/abstract=3565184 or http://dx.doi.org/10.2139/ssrn.3565184

Harjeet Bhabra

Saint Mary's University ( email )

Sobey Building 311
923 Robie Street
Halifax, Nova Scotia B3H 3C3
Canada

Pascal Francois (Contact Author)

HEC Montreal - Department of Finance ( email )

3000 Chemin de la Cote-Sainte-Catherine
Montreal, Quebec H3T 2A7
Canada
514-340-7743 (Phone)
514-340-5632 (Fax)

Thomas John Walker

Concordia University, Quebec - Department of Finance ( email )

Montreal, Quebec H3G 1M8
Canada

Chunrong Wang

Concordia University ( email )

1455 de Maisonneuve Blvd. W.
Montreal, Quebec H3G 1M8
Canada

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