Does strengthening Collective Action Clauses ( CACs ) help ?

In a model with both issues of sovereign debtor moral hazard and creditor coordination under incomplete information, we show that the resulting con‡ict between ex ante and interim e¢ ciency limits the welfare impact of strengthening CACs. Conditional on default, we show that an interim e¢ cient CAC threshold exists and improving creditor coordination results in welfare gains. However, when ex ante e¢ ciency requires the sovereign debtor to choose actions that reduce the probability of default, improved creditor coordination reduces ex ante e¢ ciency and the interim e¢ cient CAC threshold is higher than the ex ante e¢ cient CAC threshold. Keywords: Sovereign Debt, Coordination, Moral Hazard, Collective Action Clauses, Ex Ante, Ex Post, E¢ ciency. JEL classi…cation: C72, C78, D82, F34 Correspondence: Kannika Thampanishvong, School of Economics and Finance, University of St Andrews, 1 The Scores, Castlecli¤e, St Andrews, Fife, United Kingdom KY16 9AL, Tel: +44 (0) 1334 462424, Fax: +44 (0) 1334 462444, E-mail: [email protected] Acknowledgement: We thank Marcus Miller and seminar participants at Warwick, RES Conference 2005 and EEA Conference 2006 for their helpful comments. The second author would like to thank the ORS, the CSGR and Department of Economics, University of Warwick for their …nancial supports. This research was partially funded by the ESRC project RES 156-25-0032 “Moral hazard, political economy and behavioural approaches in international …nance” Preprint submitted to Elsevier Science 10 March 2009