Strategic Default and Tunneling by Firms : An Empirical Investigation

Strategic default by firms remains a global concern. Although the theoretical literature studies this phenomenon, empirical evidence is scant as data categorizing defaults as strategic or distress-driven is unavailable. We use unique data from India to investigate how firms that strategically default on their debt differ ex-ante in their behavior from distress-driven defaulters. We find that strategic defaulters tunnel cash by making large loans to related parties and these loans are significant ex-ante predictors of strategic default as against distress default. Strategic defaulters make these loans despite their own need for external financing. Further, these loans carry lower rates of interest and are repaid over significantly longer periods than loans made by distress defaulters and non-defaulters. Thus, the magnitude and contractual features of related party loans contain information on the giver's intent to strategically default on external debt