Quynh Nguyen, Katharina Pistor, Michael Hudecheck

One of the oldest traded financial assets is sovereign debt. This paper explores the conundrum of sovereign debt from the perspective of the legal theory of finance (LTF), which suggests that large-scale and complex financial systems rely on a credible promise of enforceability. Yet, these promises tend to impose more binding restrictions on some borrowing governments than others especially in times of crisis, when contractual flexibility can be critical for survival. We argue that bonds issued under foreign law are more rigid, while bonds issued under domestic provide borrowers with greater flexibility. Using an original dataset consisting of more 60,000 international bonds issued by the central governments of 23 emerging economies for the period 1990 to 2017, we examine the consequences of contractual rigidity on countries’ access to foreign debt, their likelihood to default and their ability to recover post crisis. We find that countries that issue their debts under foreign law enjoy access to debts with lower coupon rates. We also find a small but statistically significant positive effect of this contractual design on a country’s likelihood to default. Our study findings offer important lessons for the ability of countries to respond to the needs of their citizens in times of crisis, including pandemics, such as COVID-19, which has devastated the public balance sheets of low-income countries and constrained their capacity to finance their public health responses.

Katharina Pistor is Edwin B. Parker Professor of Comparative Law at the Columbia Law School. She is a leading scholar and writer on corporate governance, money and finance, property rights, and comparative law and legal institutions. Pistor is the author or co-author of nine books. Her most recent book, The Code of Capital: How the Law Creates Wealth and Inequality, examines how assets such as land, private debt, business organizations, or knowledge are transformed into capital through contract law, property rights, collateral law, and trust, corporate, and bankruptcy law.