The Problem that Wasn’t: Coordination Failures in Sovereign Debt Restructurings

Abstract

Contrary to widespread expectation, emerging market debt renegotiations in the era of bond finance have generally been quick and involved little litigation. This paper presents a model that rationalizes some of the initial fears and offers two interpretations for why they did not come true. First, when debt exchange offers are sufficiently attractive relative to the risk faced by holdouts, full participation can be an equilibrium. Second, legal innovations such as minimum participation thresholds and defensive exit consents helped coordinate creditors and avoid litigation. In this regard, exit consents are shown to have similar effects on creditor coordination as collective action clauses (CACs). Unlike CACs, exit consents can be exploited to force a high haircut on creditors, but the ability of creditors to coordinate to block exit consents limits overly aggressive use.