Study reveals factors that influence debt renegotiation in Brazil

Debt renegotiation is a common practice in financial markets, arising as a response to the incompleteness of financial contracts. When a borrower or creditor cannot fulfill or wishes to change the initial terms of a contract, a renegotiation process can be initiated. This is crucial for improving the company's financial health during times of difficulty, and can lead to grace periods or extended payment terms.

In the context of emerging markets, a study by Rafael Felipe Schiozer, from the São Paulo School of Business Administration (FGV EAESP), together with João Paulo Eça, Tatiana Albanez and Mauricio Ribeiro do Valle, was published in the Quarterly Review of Economics and Finance. The research aims to understand the determinants of debt renegotiation in Brazil.

The team collected unprecedented manual data on loan renegotiations by Brazilian companies. They analyzed more than three thousand notes to financial statements between 2010 and 2021. The sample included 11,602 quarterly observations from 326 non-financial companies listed on the Brazilian stock exchange, B3. The focus was on identifying whether, when and how renegotiations took place and what their results were.

The results show that the deterioration of companies' financial health increases the likelihood of debt renegotiation. In such cases, borrowers generally need to provide compensation to creditors, which can include additional collateral requirements, stricter restrictive clauses or higher interest rates. Thus, these compensations serve as a way of protecting creditors from the increased risk of default.

Furthermore, the motivations for debt renegotiation differ between developed and emerging economies.

This is due to the heterogeneous institutional characteristics of each jurisdiction. In emerging markets, such as Brazil, there is greater asymmetry of information and less protection for creditors, resulting in higher agency costs. This makes creditors more likely to renegotiate with companies in difficulty, preferring renegotiations to the long and costly process of recovery and sale of collateral.

As for the profile of the companies that have renegotiated their debts, they tend to be large but face greater financial difficulties. Creditors often impose stricter conditions in renegotiations with these companies, including an increase in the interest rate, covenants (restrictive clauses) and demands for additional guarantees. Furthermore, this behavior is more pronounced among bondholders, who are more likely to demand compensation than private and public banks.

The study concludes that in emerging markets, where creditor protection is lower and information asymmetry is high, compensation in debt renegotiation is a common practice aimed at reducing risk for creditors. Furthermore, these findings are essential for companies looking to renegotiate their debts, as they provide valuable insights into creditors' expectations and the possible conditions they may face. Understanding these factors allows companies to better prepare and adopt more effective strategies during the renegotiation process.

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