TY  - JOUR
AU  - Bolton,Patrick
AU  - Oehmke,Martin
TI  - Should Derivatives be Privileged in Bankruptcy?
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 17599
PY  - 2011
Y2  - November 2011
UR  - http://www.nber.org/papers/w17599
L1  - http://www.nber.org/papers/w17599.pdf
N1  - Author contact info:
Patrick Bolton
Columbia Business School
804 Uris Hall
New York, NY 10027
Tel: 212/854-9245
Fax: 212/854-8059
E-Mail: pb2208@columbia.edu

Martin Oehmke
Finance and Economics Division
Columbia Business School
3022 Broadway, Uris Hall 420
New York, NY 10027
Tel: 212/851-1804
Fax: 212/316-9180
E-Mail: moehmke@columbia.edu
AB  - Derivative contracts, swaps, and repos enjoy "super-senior" status in bankruptcy: they are exempt from the automatic stay on debt and collateral collection that applies to virtually all other claims. We propose a simple corporate finance model to assess the effect of this exemption on firms' cost of borrowing and incentives to engage in swaps and derivatives transactions. Our model shows that while derivatives are value-enhancing risk management tools, super-seniority for derivatives can lead to inefficiencies: collateralization and effective seniority of derivatives shifts credit risk to the firm's creditors, even though this risk could be borne more efficiently by derivative counterparties. In addition, because super-senior derivatives dilute existing creditors, they may lead firms to take on derivative positions that are too large from a social perspective. Hence, derivatives markets may grow inefficiently large in equilibrium.
ER  -