Abstract
Abstract We analyze the impact of the introduction of credit default swaps (CDSs) on real decision-making within the firm. Our structural model predicts that CDS introduction increases debt capacity more when uncertainty about the credit events that trigger CDS payment is lower. Using a sample of more than 56,000 firms across 51 countries, we find that CDSs increase leverage more in legal and market environments where uncertainty about CDS obligations is reduced and when property rights are weaker. Our results highlight the importance of legal uncertainty in the interpretation of the underlying trigger events of global credit derivatives.
Highlights
We analyze the impact of the introduction of credit default swaps (CDSs) on real decision-making within the firm
CDS existence as the variable of interest, rather than CDS introduction; we examine the robustness of the results when we exclude the set of firms that may be considered “national champions,” since these firms may be perceived as having meaningfully different probabilities of default
We analyze the impact of CDS introduction on real decision-making within the firm, taking into consideration features of the local economic and legal environments of firms
Summary
We analyze the impact of the introduction of credit default swaps (CDSs) on real decision-making within the firm. Christensen, Hail, and Leuz (2016) examine changes in EU market regulation across European countries and find significant differences in the effect of these directives, with liquidity benefits stronger in countries that have stricter implementation and enforcement of rules, as well as higherquality regulatory procedures Overall, these papers and other research that followed provide strong evidence that the legal environment is an important determinant of the characteristics of capital markets, whether and how firms access these markets, and the structure and effects of corporate governance inside firms. Saretto and Tookes (2013), Subrahmanyam, Tang, and Wang (2014), and Bolton and Oehmke (2015) suggest that the introduction of CDSs to underlying firms can significantly affect creditors’ ability to enforce their claim or affect their priority in bankruptcy These effects depend on the bankruptcy code to which the firms are subject and may result in changes in firms’ bankruptcy risk. A decrease in the quality of the legal system, measured by the number of days that contract enforcement requires, is associated with a significant decrease in the ratio of private credit to GDP
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