TAILIEUCHUNG - Strategic Actions and Credit Spreads: An Empirical Investigation

In the 2007-2010 financial crisis, the economies of different countries have been affected with various degrees of intensity according to their exposure to some of its main drivers. In Spain securitization activity grew spectacularly mostly in sync with large increases in bank credit to the private sector. The spectacular upward swing in the Spanish credit cycle was buttressed by relatively loose lending practices and large increases in housing prices (see Jimenez et al., 2010, and Reinhart and Rogoff, 2009). Hence the recent episode of financial instability in Spanish shares many common features with prior instances of. | THE JOURNAL OF FINANCE VOL. LXII NO. 6 DECEMBER 2007 Strategic Actions and Credit Spreads An Empirical Investigation SERGEI A. DAVYDENKO and ILYA A. STREBULAEV ABSTRACT Do strategic actions of borrowers and lenders affect corporate debt values We find higher bond spreads for firms that can renegotiate debt contracts relatively easily. Consistent with theories of strategic debt service the threat of strategic default depresses bond values ex ante even though there may be efficiency gains from renegotiation ex post. However the economic significance of the net effect is small suggesting that bondholders have considerable bargaining power. The effect of strategic actions is higher when creditors are particularly vulnerable to strategic threats including risky firms with high managerial shareholding simple debt structures and high liquidation costs. This paper explores the empirical relationship between corporate debt prices and firm characteristics that influence strategic decisions concerning default and distressed renegotiations. A large body of corporate finance literature documents the effects of firm-specific factors on the outcome of distressed restructuring. We investigate whether such factors are ref lected ex ante in the prices of nondistressed firms bonds. We find that on average the possibility of strategic default increases corporate debt spreads even though ex post there may be efficiency gains from renegotiation. The impact of strategic actions on spreads is larger for firms whose creditors are more vulnerable to the threat of strategic default including low-rated firms with few tangible assets high managerial equity ownership and simple debt structures. However despite robust statistical significance of our strategic proxies their quantitative contribution to both the average level and the cross-sectional variation of spreads for the whole sample is small. The evidence suggests that contrary to the extreme assumptions of some models bond investors are .

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