Managerial Agency and Bond Covenants

Posted: 9 Mar 2009

See all articles by Sudheer Chava

Sudheer Chava

Georgia Institute of Technology - Scheller College of Business

Praveen Kumar

University of Houston - Department of Finance

Arthur Warga

University of Houston - Department of Finance

Date Written: March 8, 2009

Abstract

Based on an analysis of the agency risk for bondholders from managerial entrenchment and fraud, we derive and test refutable hypotheses about the influence of managerial agency risk on bond covenants, using a comprehensive database of corporate bonds from 1993-2007. Managerial entrenchment and the risk of managerial fraud significantly influence the use of covenants, in the direction predicted by the agency-theoretic framework. Our analysis highlights the varied effects of entrenchment on different types of agency risks faced by bondholders: entrenched managers aggravate investment risk for bondholders, but ameliorate risk to bondholders from shareholder opportunism. Moreover, the use of covenants responds efficienctly to cross-sectional variations in the quality of information relating to the risk of managerial fraud.

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

JEL Classification: G32, G34, D82

Suggested Citation

Chava, Sudheer and Kumar, Praveen and Warga, Arthur, Managerial Agency and Bond Covenants (March 8, 2009). Review of Financial Studies, Forthcoming . Available at SSRN: https://ssrn.com/abstract=1355586

Sudheer Chava

Georgia Institute of Technology - Scheller College of Business ( email )

800 West Peachtree St.
Atlanta, GA 30308
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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