Capital Market Consequences of the Libor Scandal and Phaseout for Public Borrowers

Abstract

The London Interbank Offer Rate (LIBOR), based on inputs from banks, is plausibly the most important set of reference interest rates in the world. Following the LIBOR rigging scandal and the post-2008 decline in interbank lending underpinning LIBOR, banks and regulators have agreed to sustain LIBOR only through the end of 2021, after which, LIBOR updates are likely to cease. In this paper, we use an event-based design to study the implications of the LIBOR scandal and phaseout (LSP) on capital markets, focusing on firms with U.S.-traded public debt. Using LSP events as exogenous shocks to the optimality of existing contracts, we provide causal evidence on the effects of the LSP on firms and their stakeholders. Our findings suggest that the consequences of the LSP, as measured by stock and bond returns, are immaterial for the average firm, but negative for firms with fewer outside options to renegotiate or repurchase debt (i.e., with credit ratings below investment grade or lower interest coverage ratios). These results suggest that the negative consequences of the LSP have mostly been borne by the shareholders and bondholders of borrowers with limited options to renegotiate or repurchase debt.

Keywords: LIBOR scandal, LIBOR phaseout, debt contracting, incomplete contracting

JEL Classification: M40, G12, G14, E4