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Debt-equity swaps and the enforcement of sovereign loan contracts

  • Michael Bowe

    (Manchester School of Management, UMIST, Manchester, M60 1QD, UK)

  • James W. Dean

    (Department of Economics, Simon Fraser University, Burnaby, B.C. V5A 1S6 and Western Washington University)

Registered author(s):

    This paper analyses the incentive compatibility effects associated with restructuring sovereign debt through a debt-equity swap scheme and the analytically related issue of providing new project finance in developing countries through equity convertible bond issues. Our central result is that these initiatives can generate efficient investment incentives and also provide a partial contractual enforcement mechanism by reconciling the investment interests of debtors and their external creditors. Unlike previous analysis of the benefits of swaps, our results make no appeal to risk considerations nor invoke informational asymmetries. We also derive a necessary condition for swaps to overcome the free-rider barrier to the provision of voluntary, market-based debt relief. In contrast to Brady Plan restructurings, this condition does not rely on taxation of the capital gains accruing to non-participating creditors. The results should be viewed in the context of the structural transformation which has recently occurred in the source of capital flows to developing countries, from syndicated bank lending to the international bond markets. The analysis advocates an enhanced role for equity convertible bond issues in this resurgence of international capital market activity. © 1997 John Wiley & Sons, Ltd.

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    Article provided by John Wiley & Sons, Ltd. in its journal Journal of International Development.

    Volume (Year): 9 (1997)
    Issue (Month): 1 ()
    Pages: 59-83

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    Handle: RePEc:wly:jintdv:v:9:y:1997:i:1:p:59-83
    Contact details of provider: Web page: http://www3.interscience.wiley.com/journal/5102/home

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    1. Leonardo Bartolini & Avinash K. Dixit, 1990. "Market Valuation of Illiquid Debt and Implications for Conflicts Among Creditors," IMF Working Papers 90/88, International Monetary Fund.
    2. William R. Cline, 1995. "International Debt Reexamined," Peterson Institute Press: All Books, Peterson Institute for International Economics, number 46, May.
    3. Elhanan Helpman, 1988. "Voluntary Debt Reduction: Incentives and Welfare," NBER Working Papers 2692, National Bureau of Economic Research, Inc.
    4. Eaton, Jonathan, 1990. "Debt Relief and the International Enforcement of Loan Contracts," Journal of Economic Perspectives, American Economic Association, vol. 4(1), pages 43-56, Winter.
    5. Bulow, Jeremy & Rogoff, Kenneth S., 1989. "A Constant Recontracting Model of Sovereign Debt," Scholarly Articles 12491028, Harvard University Department of Economics.
    6. Blake, David & Pradhan, Mahmood, 1991. "Debt-equity swaps as bond conversions: implications for pricing," Journal of Banking & Finance, Elsevier, vol. 15(1), pages 29-41, February.
    7. Myers, Stewart C., 1977. "Determinants of corporate borrowing," Journal of Financial Economics, Elsevier, vol. 5(2), pages 147-175, November.
    8. Michael P. Dooley, 1988. "Buy-Backs and Market Valuation of External Debt," IMF Staff Papers, Palgrave Macmillan, vol. 35(2), pages 215-229, June.
    9. Robert C. Merton, 1973. "Theory of Rational Option Pricing," Bell Journal of Economics, The RAND Corporation, vol. 4(1), pages 141-183, Spring.
    10. Bowe, Michael & Dean, James W, 1993. "Debt-Equity Swaps: Investment Incentive Effects and Secondary Market Prices," Oxford Economic Papers, Oxford University Press, vol. 45(1), pages 130-47, January.
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