How Much is this Clause? Debt Managers on Pricing Bond Contract Terms

Abstract

Whether bond contract terms are priced is a classic question at the intersection of law and finance. One contract provision, the Collective Action Clause or CAC in sovereign bonds, has been the subject of extensive analysis in an effort to answer this question. The research, much of it quantitative, has yielded seemingly contradictory results. In this article, we come at the pricing question from a different perspective: we ask government officials responsible for executing their countries’ bond issuance strategies, how and why they choose particular contract terms in their bonds, and specifically about the relevance of pricing information to their choices. Contrary to the theories behind the empirical studies—which hold that contract terms such as CACs should affect governments’ borrowing costs, and that governments should choose terms to minimize these costs—debt managers report that they and the investors who buy their debt normally prefer contracts designed to minimize any impact of terms such as CACs on bond prices. In other words, contracts are deliberately designed to reduce the salience of terms described as “legal” (as distinct from “financial”), and to make it difficult to detect their impact on price in any given issue. The implication is that this approach would allow for the development of optimal contracts over time, without detracting from a government’s long-term debt management strategy.