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Credit Default Swaps and Lender Incentives in Bank Debt Renegotiations

Published online by Cambridge University Press:  21 July 2022

Indraneel Chakraborty ,
Sudheer Chava  and
Rohan Ganduri Open the ORCID record for Rohan Ganduri [Opens in a new window]
Indraneel Chakraborty
Affiliation:
University of Miami Herbert Business School i.chakraborty@miami.edu
Sudheer Chava
Affiliation:
Georgia Institute of Technology Scheller College of Business sudheer.chava@scheller.gatech.edu
Rohan Ganduri*
Affiliation:
Emory University Goizueta Business School
*
rohan.ganduri@emory.edu (corresponding author)
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Abstract

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Using a regression-discontinuity design and within lender–borrower variation, we analyze how credit default swaps (CDSs) affect bank incentives and borrower outcomes in renegotiations after covenant violations. While existing studies document an investment decline after covenant violations, we find that covenant-violating firms maintain their investment subsequent to the introduction of CDS trading. Moreover, after CDS introduction, covenant-violating firms are less likely to default. Our results suggest that in the private debt markets, CDSs discipline borrowers, while the empty creditor problem due to CDS is mitigated because of lenders’ reputation concerns and lower coordination frictions.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 58 , Issue 5 , August 2023 , pp. 1911 - 1942
Creative Commons
Creative Common License - CCCreative Common License - BY
This is an Open Access article, distributed under the terms of the Creative Commons Attribution licence (http://creativecommons.org/licenses/by/4.0), which permits unrestricted re-use, distribution and reproduction, provided the original article is properly cited.
Copyright
© The Author(s), 2022. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

Footnotes

We thank Murillo Campello (the referee), Lucy Chernykh, Andras Danis, Amar Gande, Jarrad Harford (the editor), Christoph Herpfer, Darren Kisgen, George Korniotis, Andrew MacKinlay, William Mann, Gonzalo Maturana, Greg Nini, Alessio Saretto, Philip Strahan, Dragon Tang, and Ji Zhou, and presentation participants at the 2016 American Finance Association Meetings, 2016 Midwest Finance Association, Boston College, Georgia Institute of Technology, Georgia State University, Louisiana State University, Southern Methodist University, University of Georgia, University of Miami, University of New South Wales, University of Technology Sydney, Wilfred Laurier University, Indian School of Business, and Indian Institute of Management, Bangalore for helpful comments and suggestions. We also thank Deep Mehta and Agam Shah for excellent research assistance.

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