Do Credit Derivatives Lower the Value of Creditor Control Rights? Evidence from Debt Covenants

Shan, Susan Chenyu; Tang, Yongjun; Winton, Andrew; Bekaert, Geert; Billett, Matthew T.; Brennan, Michael J.; Chang, Charles; Choi, James J.; Taylor, Luke; Wang, Hao; Wang, Junbo; Wang, Sarah; Wang, Tan; Wang, Yihui; Wei, Jason Chenyang; Zhang, Zhipeng; Zhu, Yingzi

doi:10.2139/ssrn.2527704

Cited by 10 publications

(15 citation statements)

References 59 publications

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“…However, recent studies show that creditor protection offered by CDS availability reduces lenders’ reliance on financial covenants. Shan, Tang, and Winton [] find that loans to CDS firms have less stringent covenants . Chakraborty, Chava, and Ganduri [] show that CDS‐protected lenders are less likely to use their control rights to intervene in borrower actions following covenant violations.…”

Section: Motivation Related Literature and Hypotheses Developmentmentioning

confidence: 99%

“…Prior studies also show that CDS availability undermines the effectiveness of financial covenants—a key monitoring mechanism in private lending. Shan, Tang, and Winton [] find that loans to CDS firms have looser covenants that are less effective as “tripwires” for loan contract renegotiations. Chakraborty, Chava, and Ganduri [] show that CDS‐protected lenders are less likely to expend effort in renegotiating loan contracts and impose weaker investment restrictions when covenants are violated.…”

Section: Introductionmentioning

confidence: 99%

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Credit Default Swaps and Managers’ Voluntary Disclosure

Kim

Shroff

Vyas³

et al. 2018

J of Accounting Research

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We investigate how the availability of traded credit default swaps (CDSs) affects the referenced firms’ voluntary disclosure choices. CDSs enable lenders to hedge their credit risk exposure, weakening their incentives to monitor borrowers. We predict that reduced lender monitoring in turn leads shareholders to intensify their monitoring and demand increased voluntary disclosure from managers. Consistent with this expectation, we find that managers are more likely to issue earnings forecasts and forecast more frequently when traded CDSs reference their firms. We further find a stronger impact of CDS availability on firm disclosure when (1) lenders have higher ability and propensity to hedge credit risk using CDSs, and (2) lender monitoring incentives and monitoring strength are weaker. Consistent with an increase in shareholder demand for public information disclosure induced by a reduction in lender monitoring, we find a stronger effect of CDSs on voluntary disclosure for firms with higher institutional ownership and stronger corporate governance. Overall, our findings suggest that firms with traded CDS contracts enhance their voluntary disclosure to offset the effect of reduced monitoring by CDS‐protected lenders.

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Section: Motivation Related Literature and Hypotheses Developmentmentioning

confidence: 99%

Section: Introductionmentioning

confidence: 99%

Credit Default Swaps and Managers’ Voluntary Disclosure

Kim

Shroff

Vyas³

et al. 2018

J of Accounting Research

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“…Shan, Tang and Winton (2014) provide evidence in favor of the latter arguments by finding that loan covenants are loosened after CDS trading.…”

Section: Empirical Evidencementioning

confidence: 92%

“…Such forces may have an ex-ante perverse effect on debt contracting such as covenants which enhance future creditor control. Shan, Tang and Winton (2014) find that debt covenants are less strict if there are CDS contracts referencing the borrower's debt at the time of loan initiation. This finding remains robustt after taking into account the selection of CDS trading.…”

Section: Hirtle (2009) Uses a Proprietary Bank Micro Data Set Of Indimentioning

confidence: 98%

Credit Default Swaps: A Survey

et al. 2014

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Credit default swaps (CDS) have been growing in importance in the global financial markets. However, their role has been hotly debated, in industry and academia, particularly after the credit crisis of 2008-2009 and the European sovereign crisis of 2010-2012. We review the extant literature on CDS that has accumulated over the past two decades. We divide our survey into seven topics after providing a broad overview in the introduction. The second section traces the historical development of CDS markets and provides an introduction to CDS contract definitions and conventions. The third section discusses the pricing of CDS, from the perspective of no-arbitrage principles as well as from that of structural and reduced-form credit risk models. It also summarizes the literature on the determinants of CDS spreads, with a focus on the role of fundamental credit risk factors, liquidity and counterparty risk. The fourth section discusses how the development of the CDS market has affected the characteristics of the related bond and equity markets, with an emphasis on the closely related concepts of market efficiency, price discovery, information flow and liquidity. Attention is also paid to the CDS-bond basis, the wedge between the pricing of the CDS and its reference bond, and the mispricing between the CDS and the equity market, which leads to a discussion on capital structure arbitrage. The fifth section examines the effect of CDS trading on firms' credit and bankruptcy risk, and how it affects corporate financial policy, including bond issuance, capital structure, liquidity management, and both external and internal corporate governance. The sixth section summarizes the literature that takes into account how CDS may impact the incentives of the various agents in the economy and the associated impact on the pricing of the contracts. In particular, we examine how CDS may alter the debtor-creditor relationship. Section seven reviews the growing literature on sovereign CDS and highlights the major conceptual and contractual differences between the sovereign and corporate CDS markets. In section eight, we discuss CDS indices, especially the role of synthetic CDS index products backed by residential mortgage-backed securities during the financial crisis. We close with our suggestions for promising future research directions on CDS contracts and markets.

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“…2 Secondly, because creditors transfer risk to CDS sellers, they may be less incentivized to monitor CDS firms (Morrison (2005)), resulting in weaker screening, debt terms (Shan, Tang, and Winton (2014) and Shan, Tang, and Winton (2015)), and discipline imposed on underperformance (Chakraborty, Chava, and Ganduri (2015)) than in the case of non-CDS firms, which is referred to as the weak monitoring hypothesis. For instance, CDS inception results in lending that is less secured (Shan, Tang, and Winton (2015)) and with less restrictive covenants (Shan, Tang, and Winton (2014)). Accordingly, whilst creditors appear generally to restrict borrowers' investment when debt covenants are violated (Chava and Roberts (2008) and Nini, Smith, and Sufi (2009)), Chakraborty, Chava, and Ganduri (2015) document that this is not the case for CDS firms.…”

mentioning

confidence: 99%

Credit Default Swaps, Financial Distress and Corporate Acquisitions

Guest,

Karampatsas,

Petmezas

et al. 2017

SSRN Journal

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Do Credit Derivatives Lower the Value of Creditor Control Rights? Evidence from Debt Covenants

Cited by 10 publications

References 59 publications

Credit Default Swaps and Managers’ Voluntary Disclosure

Credit Default Swaps and Managers’ Voluntary Disclosure

Credit Default Swaps: A Survey

Credit Default Swaps, Financial Distress and Corporate Acquisitions

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