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The Empty Creditor Hypothesis (Mengle D.)

Bank Products and Diversification Bank-Borrower Relationships

Abstract The empty creditor hypothesis suggests that bondholders and other creditors can use credit derivatives and other financial contracts to unbundle exposure to default from non-economic rights such as voting under debt agreements and in bankruptcy. According to the hypothesis, hedged creditors have weaker incentives to cooperate with distressed corporations to avoid bankruptcy and might even build up a “negative economic interest” under which failure is the preferred outcome. In addition, the hypothesis suggests that, once a firm enters bankruptcy, hedged creditors will be indifferent to the value of the firm. This paper argues that there is little if any evidence to back up the assertions of the empty creditor hypothesis. Further, given the cost of hedging distressed credits, the incentive effects of hedging are unlikely to lead systematically to behavior that would distort credit markets. Finally, because credit derivative settlement procedures essentially decouple compensation from ultimate recovery, they should in most cases have no effect on creditor behavior in bankruptcy proceedings.
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Libref/ Mengle D. (2009) “The Empty Creditor Hypothesis”, ISDA Research Notes, № 3, pp. 1-16
© Программирование — Александр Красильников, 2008
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