Holdouts in Sovereign Debt Restructuring: A Theory of Negotiation in a Weak Contractual Environment

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HOLDOUTS IN SOVEREIGN DEBT RESTRUCTURING: A THEORY OF NEGOTIATION IN A WEAK CONTRACTUAL ENVIRONMENT Rohan Pitchford Mark L. J. Wright Working Paper 16632 http://www.nber.org/papers/w16632

NATIONAL BUREAU OF ECONOMIC RESEARCH 1050 Massachusetts Avenue Cambridge, MA 02138 December 2010

While all errors are our own, we thank Rui Esteves, Daniel Klerman, Lee Ohanian, Christoph Trebesch, the editor, three anonymous referees, and numerous seminar participants for comments, and Catherine Feng and Aubrey Clark for excellent research assistance. Further comments are welcome. Pitchford acknowledges the financial support of the Australian Research Council. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research. © 2010 by Rohan Pitchford and Mark L. J. Wright. All rights reserved. Short sections of text, not to exceed two paragraphs, may be quoted without explicit permission provided that full credit, including © notice, is given to the source.

Holdouts in Sovereign Debt Restructuring: A Theory of Negotiation in a Weak Contractual Environment Rohan Pitchford and Mark L. J. Wright NBER Working Paper No. 16632 December 2010 JEL No. D23,D78,F34,K12,K33 ABSTRACT Why is it difficult to restructure sovereign debt in a timely manner? In this paper we present a theory of the sovereign debt restructuring process in which delay arises as individual creditors hold-up a settlement in order to extract greater payments from the sovereign. We then use the theory to analyze recent policy proposals aimed at ensuring equal repayment of creditor claims. Strikingly, we show that such collective action policies may increase delay by encouraging free-riding on negotiation costs, even while preventing hold-up and reducing total negotiation costs. A calibrated version of the model can account for observed delays, and finds that free riding is quantitatively relevant: whereas in

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