Download This PaperLitigation Risk and Debt Contracting: Evidence from a Natural Experiment
Journal of Law and Economics, Forthcoming
49 Pages Posted: 20 May 2020
Date Written: February 19, 2020
Abstract
In June 2001, Nevada changed its state corporate law by substantially reducing the legal liability of directors and officers for breaching fiduciary duties owed to the corporation. We examine the impact of the reduced litigation risk caused by this legislative change on Nevada-incorporated firms’ loan contract terms and related borrower-lender agency conflicts. Using a difference-in-differences analysis, we find that this legislative change leads to less favorable loan contract terms for Nevada-incorporated firms: higher spread and more restrictive covenants. In addition, after the legislative change, Nevada-incorporated firms with severe borrower-lender agency conflicts take more risk, increase payout through stock repurchase, and reduce capital investment and equity issuance. Collectively, these results suggest that the reduced litigation risk exacerbates the borrower-lender agency conflicts.
Keywords: Litigation risk, loan contracts, agency conflicts, Nevada corporate law
JEL Classification: G30, K41
Suggested Citation: Suggested Citation