The Brady Plan, 1989 Mexican Debt-Reduction Agreement, and Bank Stock Returns in United States and Japan

Abstract

The authors investigate the impact of the menu approach to debt rescheduling on the market value of two major creditors: U.S. and Japanese banks. They try to understand how major creditor banks are affected by debt reschedulings and the menu choices they make, so that debt deals can be structured in a way that appeals to both creditors and debtor countries. They measure the stock market's reaction to the announcement of the Brady Plan and the Mexican debt reduction agreement. The Brady Plan was implemented through the menu approach, which acknowledges creditor heterogeneity and provides financing packages that meet the country's financing requirements while still allowing the banks to reduce their exposure. The Mexican agreement provides an opportunity to test the impact of the Brady Plan's implementation. By examining individual bank's menu choices, exposure levels, and the market's reaction, they explore whether banks were able to make optimal portfolio choices when confronted with the obligation to participate. They show that stock prices for different groups of banks reacted quite differently to focal events. Among all banks, U.S. multinationals showed the strongest positive reaction to the Brady announcement and the Mexican agreement. U.S. non-multinationals do not appear to have been significantly affected by these international-debt-related events. The reaction experienced by all Japanese banks was much weaker than that of U.S. multinationals and was negative for the Brady announcement and the initial Mexico announcement. The authors contend that the lack of a strong reaction was because of the Japanese banks' relatively low exposure to developing country risk. They see the negative market reaction as a reflection of the expectation that a U.S.-initiated debt reduction strategy would not be favorable for Japanese banks. Indeed, after the menu choices were announced, the market recognized that the Japanese banks were treated fairly and corrected itself. They do not find that banks that made different choices were treated differently by the market, so banks were able to negotiate menu choices in their best interest and to make portfolio choices consistent with their business objectives. The results here confirm that the menu approach to debt restructuring may benefit both the creditor banks and the debtor countries.