Sovereign Debt and Moral Hazard: The Role of Collective Action and Contractual Uncertainty

45 Pages Posted: 11 Aug 2017 Last revised: 17 Dec 2021

See all articles by Marcel Kahan

Marcel Kahan

New York University School of Law; European Corporate Governance Institute

Shmuel Leshem

Independent Researcher

Date Written: August 9, 2017

Abstract

The ambiguous phrasing of pari passu (equal treatment) clauses in sovereign debt contracts has long baffled commentators. We show that in the presence of asymmetric information on a sovereign borrower's ability to pay, an uncertain clause gives rise to a collective action problem among creditors that can reduce sovereign moral hazard. By varying the clause, parties can calibrate a sovereign's expected default costs and payments to creditors and thereby optimally trade off the sovereign's moral hazard and (deadweight) default costs. As information asymmetry decreases, a pari passu clause becomes a coarser instrument for configuring creditors' incentives and mitigating moral hazard.

Keywords: Sovereign debt, pari passu clauses, strategic bargaining

JEL Classification: C72, D78, F34

Suggested Citation

Kahan, Marcel and Leshem, Shmuel, Sovereign Debt and Moral Hazard: The Role of Collective Action and Contractual Uncertainty (August 9, 2017). NYU Law and Economics Research Paper No. 17-29, European Corporate Governance Institute - Law Working Paper No. 620/2021, Available at SSRN: https://ssrn.com/abstract=3016604 or http://dx.doi.org/10.2139/ssrn.3016604

Marcel Kahan (Contact Author)

New York University School of Law ( email )

40 Washington Square South
New York, NY 10012-1099
United States
212-998-6268 (Phone)
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European Corporate Governance Institute ( email )

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1000 Brussels
Belgium

Shmuel Leshem

Independent Researcher ( email )

Los Angeles, CA

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