Skip to main content
SpringerLink
Log in

Do credit default swaps impact lenders’ monitoring of loans?

  • Original Research
  • Published:
Review of Quantitative Finance and Accounting Aims and scope Submit manuscript

Abstract

In this paper, we investigate whether lenders alter their degree of monitoring of loans given to a firm after a credit default Swap (CDS) becomes available for the firm. Using a sample of nearly 21,000 loans taken by nearly 4600 non-financial U.S firms over the period of 1996–2014, we find that lenders decrease their degree of monitoring on loans granted to a firm after the inception of the firm’s CDS. The reduction in degree of monitoring is not dependent on whether the lender holds the CDS or not. The availability of the CDS motivates the lenders to decrease the degree of monitoring of loans granted to the firm evidenced by relatively lower degree of comprehensiveness and intensity of both financial and non-financial covenants attached to the post-CDS loans. These findings are robust to loan and firm characteristics, and different measures of covenant comprehensiveness and intensity.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Similar content being viewed by others

Notes

  1. I conducted OLS regressions as well. I find qualitatively similar results.

References

  • Acharya V, Johnson T (2007) Insider trading in credit derivatives. J Financ Econ 84:110–141

    Google Scholar 

  • Ahn S, Choi W (2009) The role of bank monitoring in corporate governance: evidence from borrowers’ earnings management behavior. J Bank Financ 33:425–434

    Google Scholar 

  • Amihud Y, Garbade K, Kahan M (1999) A new governance structure for corporate bonds. Stanford Law Rev 51:447–492

    Google Scholar 

  • Amiram D, Beaver W, Landsman W, Zhao J (2017) The effect of credit default swap trading on information asymmetry of syndicated loans. J Financ Econ 126:364–382

    Google Scholar 

  • Arentsen E, Mauer D, Rosenlund B, Zhang H, Zhao F (2015) Subprime mortgage defauls and credit default swaps. J Financ 70:689–731

    Google Scholar 

  • Ashcraft A, Santos J (2009) Has the CDS market lowered the cost of debt? J Monet Econ 56:514–523

    Google Scholar 

  • Bai X, Hu N, Liu L, Zhu L (2017) Credit derivatives and stock return synchronicity. J Financ Stab 28:79–90

    Google Scholar 

  • Batta G, Qui J, Yu F (2015a), Credit derivatives and earnings announcement, Working Paper

  • Bharath S, Shumway T (2008) Forecasting default with the Merton distance to default model. Rev Financ Stud (21):1339–1369

    Google Scholar 

  • Bolton P, Oehmke M (2011) Credit default swaps and the empty creditor problem. Rev Financ Stud 24:2617–2655

    Google Scholar 

  • Bradley M, Roberts M (2015) The structure and pricing of corporate debt covenants. Q J Financ 5:36–74

    Google Scholar 

  • Campello M, Matta R (2012) Credit default swaps and risk-shifting. Econ Lett 117:639–641

    Google Scholar 

  • Chakraborty I, Chava S, Ganduri R (2015b), Credit default swaps and moral hazard in bank lending. Working Paper

  • Chang X, Chen Y, Wang S, Zhang K, Zhang W (2017a) Credit default swaps and corporate innovation. J Financ Econ 134(2):474–500

    Google Scholar 

  • Chava S, Roberts M (2008) How does financing impact debt investment? The role of debt covenants. J Finan 63(5):2085–2121

    Google Scholar 

  • Che Y, Sethi R (2014) Credit market speculation and the cost of capital. Am Econ J 6:1–34

    Google Scholar 

  • Danis A, Gamba A (2018) The real effects of credit default swaps. J Financ Econ 127:51–76

    Google Scholar 

  • Danis A (2016) Do empty creditors matter? Evidence from distressed exchange offers. Manage Sci 63:1285–1301

    Google Scholar 

  • Datta S, Datta M, Patel A (2000) Some evidence on the uniqueness of initial public debt offerings. J Financ 55:715–743

    Google Scholar 

  • Datta S, Datta M, Patel A (1999) Bank monitoring and the pricing of corporate public debt. J Financ Econ 51:435–449

    Google Scholar 

  • Demiroglu C, James C (2010) The information content of bank loan covenants. Rev Financ Stud 23:3700–3737

    Google Scholar 

  • Drucker S, Puri M (2009) On loan sales, loan contracting, and lending relationships. Rev Financ Stud 22:2835–2872

    Google Scholar 

  • Frankel R, Litov L (2007) Financial accounting characteristics and debt covenants. SSRN J 145:42. https://doi.org/10.2139/ssrn.978711

    Article  Google Scholar 

  • Fuller K, Yildiz S, Uymaz Y (2018) Credit default swaps and firms’ financing policies. J Corp Financ 48:34–48

    Google Scholar 

  • Gorton G, Kahn J (2000) The design of bank loan contracts. Rev Financ Stud 13:331–364

    Google Scholar 

  • Guest P, Karampatsas N, Petmezas D, Travlos NG (2016) Credit default swaps and corporate acquisitions. Working Paper

  • Halle G, Santos J (2009) Do banks price their information monopoly? J Financ Econ 93:185–206

    Google Scholar 

  • Halle G, Santos J (2008) The decision to first enter the public bond market: the role of firm reputation, funding choices, and bank relationships. J Bank Financ 32:1928–1940

    Google Scholar 

  • Holmstrom B, Tirole J (1997) Financial intermediation, loanable funds, and the real sector. Quart J Econ 112:663–691

    Google Scholar 

  • Hong L, Sirmans S, Xie K (2017b) Credit default swaps, equity risks, and corporate risk taking. Working Paper

  • Hong J, Na W (2021) The effects of credit default swaps on corporate investment. Eur J Financ 27:260–277

    Google Scholar 

  • Hu H, Black B (2008) Debt, equity, and hybrid decoupling: governance and systematic risk implications. Eur Financ Manag (14):663–709

    Google Scholar 

  • Jensen M, Meckling W (1976) Theory of firm: Managerial behavior, agency costs and ownership structure. J Financ Econ 3:305–360

    Google Scholar 

  • Kim J, Shroff P, Vyas D, Wittenberg-Moerman R (2018) Credit default swaps and managers’ voluntary disclosure. J Account Res 56:953–988

    Google Scholar 

  • Mansi S, Qi Y, Wald JK (2012) Debt covenants and bankruptcy risk. SSRN Electron J. https://doi.org/10.2139/ssrn.1805038

    Article  Google Scholar 

  • Martin X, Roychowdhury S (2015) Do financial market developments influence accounting practices? Credit default swaps and borrowers׳ reporting conservatism. J Account Econ 59:80–104

    Google Scholar 

  • Murfin J (2012) The supply-side determinants of loan contract strictness. J Financ 67:1565–1601

    Google Scholar 

  • Nini G, Sufi A, Smith D (2012) Creditor control rights, corporate governance and firm value. Rev Financ Stud 25:1713–1761

    Google Scholar 

  • Nini G, Sufi A, Smith D (2009) Creditor control rights and firm investment policy. J Financ Econ 92:400–420

    Google Scholar 

  • Parlour C, Winton A (2013) Laying off credit risk: Loan sales versus credit default swaps. J Financ Econ 107:25–45

    Google Scholar 

  • Qui L, Liu R, Jin Y, Ding C, Fan Y, Yeung A (2022) Impact of credit default swaps on firms’ operational efficiency. Prod Oper Manag 31:3611–3631

    Google Scholar 

  • Rajan R, Winton A (1995) Covenants and collateral as incentives to monitor. J Financ 50:1113–1146

    Google Scholar 

  • Roberts MR, Whited TM (2013) Endogeneity in empirical corporate finance1. Elsevier. https://doi.org/10.1016/B978-0-44-453594-8.00007-0

    Chapter  Google Scholar 

  • Saretto A, Tookes H (2013) Corporate leverage, debt maturity and credit supply: the role of credit default swaps. Rev Financ Stud 26:1190–1247

    Google Scholar 

  • Shan C, Tang D, Winton A (2019) Do banks still monitor when there is a market for creditor protection? J Account Econ 68:101241

    Google Scholar 

  • Shan SC, Tang DY, Yan H (2014) Credit default swaps and bank risk taking. SSRN Electron J. https://doi.org/10.2139/ssrn.2378272

    Article  Google Scholar 

  • Smith C, Warner J (1979) On financial contracting: an analysis of bond covenants. J Financ Econ 7:117–161

    Google Scholar 

  • Subrahmanyam M, Tang D, Wang S (2014) Does the tail wag the dog?: the effect of credit default swaps on credit risk. Rev Financ Stud 27:2927–2960

    Google Scholar 

  • Susteric J (2012) Do traded credit default swaps impacts lenders’ monitoring activities? Evidence from private loan agreements. Ohio State University, UK

    Google Scholar 

  • Vashishtha R (2014) The role of bank monitoring in borrowers’ discretionary disclosure: evidence from covenant violations. J Account Econ 57:176–195

    Google Scholar 

  • Wu W, Fok R, Chang Y, Chen C (2022) Credit default swaps and corporate performance smoothing. J Corp Finan 75(1–24):102240

    Google Scholar 

  • Zhao C, Li Y, Govindaraj S, Zhong Z (2022) CDS trading and analyst optimism. Br Account Rev 54(1–17):101109

    Google Scholar 

Download references

Funding

Funding

The authors acknowledge financial support from CPA Ontario.

Author information

Authors and Affiliations

  1. Royal Military College of Canada, Kingston, Canada

    Naceur Essaddam

  2. University of North Carolina, Wilmington, USA

    Miran Hossain

  3. Bissett School of Business, Mount Royal University, Calgary, Canada

    Tashfeen Hussain

Authors
  1. Naceur Essaddam
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. Miran Hossain
    View author publications

    You can also search for this author in PubMed Google Scholar

  3. Tashfeen Hussain
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to Naceur Essaddam.

Additional information

Publisher's Note

Springer Nature remains neutral with regard to jurisdictional claims in published maps and institutional affiliations.

Appendix 1

Appendix 1

See (Table

Table 16 Regression Variable Definitions and Data Sources
Full size table

16).

Rights and permissions

Reprints and permissions

About this article

Check for updates. Verify currency and authenticity via CrossMark

Cite this article

Essaddam, N., Hossain, M. & Hussain, T. Do credit default swaps impact lenders’ monitoring of loans?. Rev Quant Finan Acc 61, 567–600 (2023). https://doi.org/10.1007/s11156-023-01159-y

Download citation

  • Accepted:

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s11156-023-01159-y

Keywords

JEL Classification

Search

Navigation