Holdouts in Sovereign Debt Restructuring: A Theory of Negotiation in a Weak Contractual Environment

Abstract

Negotiations between a country in default and its international creditors are modeled as a dynamic game in an environment of weak contractual enforcement. The country cannot borrow internationally until it settles with all creditors. Delay arises in equilibrium as creditors engage in strategic hold-up. The model a¢ rms the conventional wisdom that delay increases with more creditors, and with the advent of vulture creditors. Contrary to conventional wisdom, putting collective action clauses into bond contracts may increase delay via free-riding on negotiation costs, even while preventing strategic holdup and reducing total negotiation costs. Secondary debt markets consolidate debt with high— and disperse debt with low— creditor bargaining power. Whether secondary markets reduce or increase delay, depends on the interaction between strategic holdup and debt