Dark Knights: The Rise in Firm Intervention by CDS Investors

We document an increase in cases where credit default swap (CDS) investors intervene in the restructuring of a distressed firm. In our theoretical analysis, we show that—contrary to popular belief—intervention by CDS investors is not necessarily reducing firm value. While the equilibrium CDS spread seems excessive for the protection buyer, that cost is offset by the reduced probability of liquidation. Ex ante borrowing costs go down, and investment and firm value both increase. Under certain assumptions, investment reaches first-best. Our results suggest that the empty creditor problem could be at least partially solved by CDS investor intervention.