Holdouts in sovereign debt restructuring: A theory of negotiation in a weak contractual environment

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 analyse 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 simple low-cost debt-restructuring operations, collective mechanisms will reduce delay by more than 60%, in high-cost complicated restructurings, the adoption of such mechanisms results in a doubling of delay.