Anticipating Venezuela’s Debt Crisis: Hidden Holdouts and the Problem of Pricing Collective Action Clauses

Authors

Robert E. Scott
Stephen J. Choi
Mitu Gulati, Duke Law SchoolFollow

Document Type

Article

Publication Date

2020

Abstract

A creditor who asks for stronger enforcement rights upon its debtor’s default will rationally accept a lower interest rate reflecting the greater expected recovery the exercise of those rights provides. Over a dozen studies, however, have failed to document this basic relationship in the context of the collective action clause, a key provision in sovereign bonds. We conjecture that this failure is because enforcing the rights in question requires collective decision-making among anonymous creditors with different interests, impeding market predictions regarding future price effects. The pricing of rights that require collective enforcement thus turns on whether the market observes an activist creditor willing to serve as a collectivizing agent to enforce the relevant rights in litigation. When activist creditors, intent on litigating, hide from the market in order to enhance their returns, the market lacks the information to price the collective rights accurately. In this Article, we use data from Venezuela’s ongoing debt crisis to test this collective action story. Our data provides evidence of the absence of price differences in contract terms that require collective decision-making for enforcement. Conversely, we find that in those situations where the market identifies the presence of an activist creditor, the relevant rights do get priced. This evidence sheds light on how the absence of efficient pricing of terms in these collective markets can impede efforts by defaulting sovereign debtors, like Venezuela, to restructure their obligations. Moreover, the timing of when such terms are priced is critical for social welfare. Because collective action clauses that provide strong enforcement rights are not priced at the time the sovereign issues bonds, sovereigns are not given the right incentives to adopt these terms at the outset.

Citation

Robert E. Scott et al., Anticipating Venezuela’s Debt Crisis: Hidden Holdouts and the Problem of Pricing Collective Action Clauses, 100 Boston University Law Review 253-300 (2020)