Empty creditors join empty voters in short-selling strategies

It's fair to say that short-selling gets a lot of bad press, despite the best efforts of practitioners and scholars to explain the value of having someone willing to provide the liquidity when markets seem to be headed in only one direction – up. This issues in short-selling comes, however, when the market is headed in the other direction and when short-sellers' actions seems to exacerbate the decline. According to a study done at the London School of Economics with a New York consulting firm, however, a more nuanced picture appears than the rapacious raiders of the popular press. Hedge fund strategies often involve trading in more than one instrument at the same time, even more than one security of the same issuer. The researchers investigated how the so-called "non-traditional" funds operate when dealing in the securities of distressed companies, ones that seem certain to be heading for a financial restructuring. In such cases, the strategy might involve selling the equity of the company short while retaining voting rights to the shares – a phenomenon known as empty voting. But if the fund is also a debt holder, its economic interest at a special shareholders meeting would be to press for a deal that would favour debtholders over shareholders. "This enables the funds to vote on the restructuring proposals of distressed firms, while at the same time they separate their voting rights from their economic exposure," they write. "The effect on firm value depends on the discrepancy between the markets for debt and equity, discrepancy in how each assesses the probability of a proposal being accepted. We show that if the assessments between the two markets are different then the presence of a non-traditional fund decreases firm value. Firm value, however, is unaffected if the assessments are the same." They call it empty creditors.

Source document: The working paper "Trading and Voting in Distressed Firms," by Konstantinos Zachariadis at the London School of Economics and Ioan Olaru of Cornerstone Research, is a 37-page pdf file.