Abstract

http://ssrn.com/abstract=989342
 
 

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Managerial Moral Hazard and Bond Covenants


Sudheer Chava


Georgia Institute of Technology - College of Management

Praveen Kumar


University of Houston - Department of Finance

Arthur Warga


University of Houston - Department of Finance

May 26, 2007


Abstract:     
Based on an analysis of the agency risk for bondholders from managerial entrenchment and fraud, and using an efficient contracting framework, we derive and test refutable hypotheses about the influence of managerial moral hazard on the use of bond covenants. Entrenched managers can both exacerbate and ameliorate bondholder agency risk, and the influence of fraud risk on bond covenants is determined by the quality of information on the firms' net assets and economic prospects. Our empirical analysis indicates that managerial entrenchment and the risk of managerial fraud significantly influence the use of covenants, in the direction predicted by our agency-theoretic analysis. Moreover, the use of covenants responds to cross-sectional variations in the firms' informational environment that influence the risk of managerial fraud. We also find that the Sarbanes-Oxley Act (SOX) has not significantly influenced the overall use of bond covenants; however, the passage of SOX appears to have reduced the agency risk to bondholders from managerial moral hazard with respect to investment.

Number of Pages in PDF File: 57

Keywords: Managerial entrenchment, Fraud, Bond covenants, Contracting efficiency

JEL Classification: G32, G34, D82

working papers series


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Date posted: May 29, 2007  

Suggested Citation

Chava, Sudheer and Kumar, Praveen and Warga, Arthur, Managerial Moral Hazard and Bond Covenants (May 26, 2007). Available at SSRN: http://ssrn.com/abstract=989342 or http://dx.doi.org/10.2139/ssrn.989342

Contact Information

Sudheer Chava
Georgia Institute of Technology - College of Management ( email )
800 West Peachtree St., NW
Atlanta, GA 30308-1149
United States
HOME PAGE: http://www.prism.gatech.edu/~schava6/
Praveen Kumar (Contact Author)
University of Houston - Department of Finance ( email )
Houston, TX 77204
United States
713-743-4770 (Phone)
713-743-4789 (Fax)
Arthur Warga
University of Houston - Department of Finance ( email )
Houston, TX 77204
United States
713-743-4779 (Phone)
713-743-4789 (Fax)
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