Publication Type

Journal Article

Version

acceptedVersion

Publication Date

6-2023

Abstract

In this paper, we examine the effect of credit defaults swaps (CDS) initiation on reference firms' cost management strategies. CDS contracts provide insurance protection for creditors, inducing a shift in bargaining power from borrowers to creditors and an excessive incidence of bankruptcy. Anticipating more intransigent creditors in debt renegotiations and higher bankruptcy risk, CDS firms are incentivized to mitigate risk through decreasing cost stickiness after CDS initiation, as cost stickiness lowers liquidity and triggers early covenant violations. We find that, on average, CDS initiation is associated with a decline in reference firms' cost stickiness. This association is more pronounced for less liquid, financially distressed, and lower credit quality firms. We also find that CDS firms with a reduction in cost stickiness will exhibit lower future bankruptcy risk than CDS firms without such as reduction in stickiness. Collectively, our findings suggest that the CDS-induced "empty creditor problem" causes reference firms to undertake more conservative cost management practices to alleviate downside risk.

Keywords

Credit risk, Credit default swaps, Empty creditors, Cost management, Cost stickiness, Cost behavior

Discipline

Corporate Finance | Databases and Information Systems | Finance and Financial Management

Research Areas

Finance

Publication

Journal of Corporate Finance

Volume

80

First Page

1

Last Page

27

ISSN

0929-1199

Identifier

10.1016/j.jcorpfin.2023.102401

Publisher

Elsevier

Copyright Owner and License

Authors

Additional URL

https://doi.org/10.1016/j.jcorpfin.2023.102401

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