Abstract

http://ssrn.com/abstract=902910
 
 

Citations (7)



 
 

Footnotes (124)



 


 



Bond Covenants and Creditor Protection: Economics and Law, Theory and Practice, Substance and Process


William W. Bratton


Institute for Law and Economics, University of Pennsylvania Law School; European Corporate Governance Institute (ECGI)


European Business Organization Law Review (EBOR), Forthcoming
Georgetown Law and Economics Research Paper No. 902910

Abstract:     
This article examines contractual protection of unsecured financial creditors in US credit markets. Borrowers and lenders in the United States contract against a minimal legal background that imposes the burden of protection on the lender. A working, constantly updated, set of contractual protections has emerged in response. But actual use of available contractual technology varies widely, depending on the level of risk and the institutional context. The credit markets sort borrowers according to the degree of the risk of financial distress, imposing substantial constraints only on the borrowers with the most dangerous incentives. At the same time, the contracting practice is sticky and lumpy, never quite managing to conform to the predictions of first generation agency theory. Levels of protection vary with institutional contexts. Exhaustive contracts providing something approaching complete protection against agency costs prove feasible only in relational contexts conducive to ongoing renegotiation over time due to small numbers of lenders operating under reputational constraints. The public bond markets do not hold out such a process context, and accordingly shut out the riskiest borrowers. The larger, less risky firms that do gain access to the bond markets borrow under contracts offering incomplete protection, with the level of protection roughly correlating to the borrower's risk level. This leaves bondholders confronting a residuum of agency costs and relying on secondary protections like monitoring, exit, diversification, and hedging. This has worked reasonably well in practice, subject to an historical exception concerning the risk of high-leverage restructuring. The bond markets searched for two decades for a stable solution to this problem, finally settling on across-the-board contractual protection only in recent years.

Number of Pages in PDF File: 37

Keywords: agency costs, bank loans, bonds and bondholders, bond covenants, creditors' rights, legal capital, private placements, trust indentures

JEL Classification: G32, K12, K22

Accepted Paper Series


Download This Paper

Date posted: May 17, 2006  

Suggested Citation

Bratton, William W., Bond Covenants and Creditor Protection: Economics and Law, Theory and Practice, Substance and Process. European Business Organization Law Review (EBOR), Forthcoming; Georgetown Law and Economics Research Paper No. 902910. Available at SSRN: http://ssrn.com/abstract=902910

Contact Information

William Wilson Bratton (Contact Author)
Institute for Law and Economics, University of Pennsylvania Law School ( email )
3501 Sansom Street
Philadelphia, PA 19104
United States
European Corporate Governance Institute (ECGI) ( email )
c/o ECARES ULB CP 114
B-1050
Brussels
Belgium
HOME PAGE: http://www.ecgi.org
Feedback to SSRN


Paper statistics
Abstract Views: 4,259
Downloads: 1,108
Download Rank: 9,371
Citations:  7
Footnotes:  124
People who downloaded this paper also downloaded:
1. The Essential Elements of Corporate Law
By John Armour, Henry Hansmann, ...

© 2014 Social Science Electronic Publishing, Inc. All Rights Reserved.  FAQ   Terms of Use   Privacy Policy   Copyright   Contact Us
This page was processed by apollo5 in 0.282 seconds