Product Market Competition with CDS

Abstract

We show that firms grow faster than their industry rivals if there are credit default swaps (CDS) referencing their debt. Using multiple approaches to addressing endogeneity concerns including synthetic difference-in-differences and novel instrumental variables, we find the product market effects of CDS likely to be causal. We provide evidence for two mechanisms driving the CDS effects: the reduction of creditor monitoring and the elevation of shareholder risk-taking. A detailed analysis of product market dynamics reveals that CDS firms achieve faster growth by reducing markups, developing new products, and encroaching on rivals’ product space. Over the long run, these strategies increase industry concentration and help profitability growth. Consistent with the classic predation theories, our findings suggest that financial innovations that change incentive problems in financial contracting can have real effects on product market outcomes.

Keywords: Credit Default Swaps, Credit Protection, Product Market Competition

JEL Classification: G32 L11