Michael Bradley & Mitu Gulati

1820-1980 – Sovereign bonds almost never contained “collective action” provisionsContract terms were “individual rights” that each holder had (unanimous approval needed to alter a bond)Problem: costly and slow restructurings can have externalities (necessitate bailouts)After Mexico 2005 and US bailout, policy solution was: Allow Collective Action

Making Restructurings Easier will Induce Irresponsible Debtor Behavior b/c costs of default are lower

Ex ante, cost of capital will rise Will be especially like to rise for the weakest

issuers whom the markets trust the least Corporate Analogy – We see the weakest

issuers having to consent to the toughest contract restrictions

The Idea of using CACs in Eurozone Sovereign Bonds was first announced in November 2010

Markets did not appear pleased with PSI talk (Story – CACs are a signal of PSI)

If this CAC/Signal story is right, will their inclusion starting in 2013, increase borrowing costs?

Prior study (E&M, 2000; 04) says yes & no (yes for poor counties; no for rich ones)

It was all done with data prior to 2003 Prior to 2003, the two dominant markets (NY &

UK) used separate standards (NY – no CAC; UK – CAC)

Cannot do a within-country test of the effects of CACs

After 2003; much more variation in both NY and UK

In any event, Eurozone question is not about unanimity versus 0.75

2003-2011 Thomson One Banker – 700 bonds for U.K. and

N.Y. law issuances Cannot test the question prior studies

examined (shift from unanimity to 75%) Can examine the variation in Modification

Votes; Acceleration and Trustee/Committee data

Focused exclusively on the effect of a shift from unanimity to .75 to change payment terms of bond

Today – almost no unanimity terms left (US Treasury Initiative in 2003) – and almost no variation in U.S.

We can test other forms of CACness .75 to .1875 continuum Acceleration; Trustees

0

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CAC

Total

Figure 1. Total Number of NY Issues, Number with CACs

0

5

10

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Nu

mb

er

pf

Bo

nd

s

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

0.75

0.50

0.38

0.25

0.19

Figure 3. Minimum Percentage Votes to Modify Payment Terms in English Bonds

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30

40

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

German

Others

English

NY

Figure 11. Total Number of Issues by Governing Law

Panel 1: NY Law Bonds Panel 2: English Law BondsIndependent Total Investment Grade Non-Investment Grade Total Investment Grade Non-Investment Grade

Variables

Ratings:

AAA . -1.58***(-3.237)

AA -2.05*** -1.17*(-6.76) (-1.77)

A -0.49 -1.63***(-1.25) (-3.33)

BB 1.22*** 0.32(4.06) (0.55)

B 1.63*** 3.13***(5.03) (2.98)

Bank -0.03 -0.19*** 0.02* -0.05 -0.03 -0.02(-1.39) (-3.83) (1.72) (-1.50) (-0.58) (-0.62)

Shelf 0.14 0.65 0.14(0.72) (1.66) (0.14)

Amount 0.16 0.35 1.05(0.81) (1.62) (1.79)

Vote 3.95*** 0.81 14.18*** 0.88 -0.48 8.51***(2.83) (0.45) (7.08) (1.09) (-.57) (4.23)

Euro -0.25 0.06 -0.11(-0.60) (0.14) (-0.18)

Pound -0.25 -0.17 .(-0.49) (-0.39)

Constant -0.83 1.49 -7.36*** 1.13 -0.78 -5.60(-0.72) (1.04) (-4.64) (1.00) (-0.69) (-1.63)

Adjusted R2 0.44 0.27 0.03 0.58 -0.01 0.64Observatons 155 57 97 79 65 15

Panel 1: NY Law Bonds Panel 2: English Law BondsIndependent Total Investment Grade Non-Investment Grade Total Investment Grade Non-Investment Grade

Variables

AAA . -1.46***(-4.52)

AA -1.58*** -0.69(-4.97) (-1.53)

A -0.37 -2.04***(-0.77) (-3.52)

BB 1.06*** -0.93*(3.43) (-1.72)

B 1.48*** 3.75***(4.41) (4.53)

Bank -0.05 -0.21*** 0.02** -0.04 -0.06 0.37(-1.54) (-3.77) (2.27) (-1.00) (-1.39) (0.94)

Shelf 0.21 0.11 0.32(0.65) (0.28) (0.91)

Amount 0.17 0.38** 0.54(1.21) (2.37) (1.06)

Vote 3.51 7.61*** 13.16*** -1.82* -2.01** 8.29***(1.51) (20.08) (2.90) (1.83) (-2.11) (6.42)

Disenfran 0.07 1.45 -0.20 1.5*** 1.25*** -0.52(0.16) (6.21)*** (-0.53) (3.28) (3.60) (-0.79)

Euro 0.20 -0.02 0.08(0.77) (-0.05) (0.14)

Pound 0.16 -0.59 .(0.35) (-1.69)

Constant -0.39 -4.28*** -6.65** 1.55** -0.61 -4.12(-0.21) (-9.99) (-1.91) (2.06) (-0.81) (-1.57)

Adjusted R2 0.34 0.34 0.00 0.61 18.00 0.81Observatons 140 52 87 78 62 14

Panel 1: NY Law Bonds Panel 2: English Law BondsIndependent Total Investment Grade Non-Investment Grade Total Investment Grade Non-Investment Grade

Variables

Ratings:

AAA . -1.57***(-3.50)

AA -2.04*** -1.11*(-6.14) (-1.70)

A -0.30 -1.42**(-0.61) (-2.57)

BB 1.2*** 0.14(4.00) (0.25)

B 1.67*** 3.25***(4.44) (3.29)

Bank -0.03 -0.2*** -0.01 -0.04 -0.04 0.20(-1.19) (-3.72) (-0.43) (-0.77) (-0.47) (1.10)

Shelf 0.11 0.87 0.02(0.53) (1.73) (0.0.)

Amount 0.21 0.03 0.41(1.04) (0.09) (1.11)

Vote 3.49** 0.98 10.56*** -0.60 -2.96 7.69***(2.08) (1.00) (5.70) (0.45) (-1.06) (8.34)

ACC 0.06 0.65** -1.14** -0.16 1.92 -0.75**(0.15) (2.26) (-2.65) (-0.26) (1.18) (-2.84)

Euro -0.03 0.33 0.10(-0.07) (0.67) (0.25)

Pound -0.26 -0.25 .(-0.49) (-0.53)

Constant -0.50 0.76 -3.37** 0.96 1.22 -2.16(-0.35) (0.73) (-2.06) (0.87) (0.54) (-1.09)

Adjusted R2 41.00 0.24 0.07 0.49 0.07 0.83

Observatons 146 52 92 80 68 14

Panel 1: NY Law Bonds Panel 2: English Law BondsIndependent Total Investment Grade Non-Investment Grade Total Investment Grade Non-Investment Grade

Variables

Ratings:

AAA . -2.09***(-3.74)

AA -1.82*** -1.53*(-3.57) (-2.01)

A 0.20 2.76***(0.48) (-3.37)

BB 1.23*** -1.69*(4.30) (-1.83)

B 1.97*** 2.76**(7.38) (2.49)

Bank -0.06* -0.19*** 0.3* -0.08 -0.05 0.30(-2.04) (-3.54) (1.72) (-1.37) (-0.97) (1.29)

Shelf 0.25 0.03 0.28(1.20) (0.08) (1.31)

Amount 0.05 0.4* 0.54(0.23) (1.95) (1.141)

Vote 2.18 2.08** 14.4*** -2.56 -2.17 9.23***(1.00) (1.96) (5.47) (-1.53) (-1.24) (9.51)

Trust / Com -0.10 0.23 0.29 1.91** 0.99 -1.3**(-0.37) (0.42) (0.99) (2.18) (1.30) (-2.67)

Euro 0.55 0.22 0.03(1.20) (0.46) (0.12)

Pound 0.52 -0.11 .(0.74) (-0.28)

Constant 0.48 1.25 -7.72*** 0.52 -0.85 -3.48(0.28) (1.58) (-3.08) (1.82)* (-0.79) (-1.33)

Adjusted R2 0.43 0.28 0.04 0.52 0.06 0.89

Observatons 136 49 87 82 63 14

Weaker issuers should have to use tougher (more constraining) contract terms

Ghanaian Contracts versus U.S. Treasury issues

But we find that the market wants to give weaker issuers more flexible contract terms?

Suspicious Move from Cross Section to Longtitudinal

Analysis

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