Bond Restructuring and Moral Hazard: Are Collective Action Clauses Costly?

IMF Working Papers, August 1, 2001

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Many official groups have endorsed the wider use by emerging market borrowers of contract clauses which allow for a qualified majority of bondholders to restructure repayment terms in the event of financial distress.
Some have argued that such clauses will be associated with moral hazard and increased borrowing costs.
This paper addresses this question empirically using primary and secondary market yields and finds no evidence that the presence of collective action clauses increases yields for either higher- or lower-rated issuers.
By implication, the perceived benefits from easier restructuring are at least as large as any costs from increased moral hazard.

Core question: Do collective action clauses (CACs) increase borrowing costs by creating moral hazard?
Data used: primary market yields and secondary market yields (as described in the summary).
Issuer coverage: higher-rated and lower-rated issuers in emerging market contexts (as described in the summary).

No evidence that the presence of collective action clauses increases yields for either higher- or lower-rated issuers.
The perceived benefits from easier restructuring are at least as large as any costs from increased moral hazard.

Wider use of collective action clauses by emerging market borrowers does not appear to raise bond yields, suggesting limited or no market penalty in terms of borrowing costs.
Easier restructuring facilitated by CACs may deliver net benefits that offset concerns about moral hazard.