I study how shareholder litigation affects the cost of bank loans via its impact on the distribution of bankruptcy estate and the conflict of interests between shareholders and creditors. Using a natural experiment based on a ruling by the Ninth Circuit Court of Appeals, I find that increasing the difficulty of class action suits decreases loan spreads. The effect is stronger for firms with higher institutional ownership, which is consistent with the argument that class actions suits help shareholders extract wealth from creditors when the firm is in bankruptcy. Further analysis shows that the effect is weaker for firms with stronger creditor protection in bankruptcy.

Credit ratings group firms by risk, yet yields are shown to overlap between firms of adjacent ratings. We model this by considering the residual risk arising from differences in the parameters of each firm's value process for firms with the same rating. To do so, our framework simultaneously incorporates jump default with Markov-governed likelihoods and continuous defaults in a default-barrier framework. We provide closed-form approximations for expected default time and tail probabilities, and empirically fit the S-shaped yield curve, intra-rating spread, and inter-rating overlap. Results are robust to time period, rating system, sub-rating, and common characteristics such as liquidity.