Credit Default Swaps and the Cost of Capital
77 Pages Posted: 24 Apr 2020 Last revised: 13 Oct 2020
Date Written: March 31, 2020
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: Suggested Citation