Creditor Control Rights, Corporate Governance, and Firm Value
University of Pennsylvania - Finance Department
University of Chicago - Booth School of Business; NBER
David C. Smith
University of Virginia - McIntire School of Commerce
December 11, 2011
We provide evidence that creditors play an active role in the governance of corporations well outside of payment default states. By examining the SEC filings of all U.S. nonfinancial firms from 1996 through 2008, we document that, in any given year, between 10 percent and 20 percent of firms report being in violation of a financial covenant in a credit agreement. We show that violations are followed immediately with a decline in acquisitions and capital expenditures, a sharp reduction in leverage and shareholder payouts, and an increase in CEO turnover. The changes in the investment and financing behavior of violating firms coincide with amended credit agreements that contain stronger restrictions on firm decision-making; changes in the management of violating firms suggest that creditors also exert informal influence on corporate governance. Finally, we show that firm operating and stock price performance improve following a violation. We conclude that actions taken by creditors increase the value of the
average violating firm.
Number of Pages in PDF File: 79
Keywords: covenants, covenant violations, corporate governance, creditors, control rights, CEO turnover, acquisition
JEL Classification: G34, G30, G31, G32, G33working papers series
Date posted: August 17, 2009 ; Last revised: December 14, 2011
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