Credit default swaps and shareholder monitoring

Abstract

The paper examines how the initiation of credit default swaps (CDSs) influences shareholders' monitoring intensity. Prior studies show that CDSs decrease lenders' monitoring over the referenced firm (Morrison, 2005; Parlour and Winton, 2013). However, there is scant literature on how shareholders react after the initiation of CDSs. Given that the reduced lenders' monitoring could be detrimental to shareholders, we predict that shareholders will directly increase their monitoring intensity. Using a difference-in-differences design, we document that the sensitivity of the voting approval rate on director elections to firm performance increases significantly after the initiation of CDSs. The effect is more evident for firms with higher risk, lower existing shareholders' monitoring intensity, and higher existing lenders' monitoring intensity. Collectively, the results provide direct evidence that shareholders step in after the initiation of CDSs by enhancing their monitoring intensity.