Download this Paper Open PDF in Browser

Corporate Governance and Covenants in Debt Contracts

72 Pages Posted: 19 Jan 2012 Last revised: 1 May 2014

Xi Li

London School of Economics

A. Irem Tuna

London Business School

Florin P. Vasvari

London Business School

Date Written: April 30, 2014

Abstract

We investigate the association between direct debtholder monitoring via bond covenants and delegated monitoring via borrowers’ corporate governance mechanisms. We find that bond contracts include fewer covenants when the borrower’s corporate governance is more effective in mitigating the agency risk of debt. Bond contracts have fewer covenants when the borrowing firm’s board size is larger, board members have more expertise, the firm has more activist shareholders and there are fewer powerful insiders on the board or blockholders. We document that these associations vary cross-sectionally with debtholders’ monitoring efficiency. Bondholders rely more on corporate governance monitoring mechanisms when borrowers are informationally opaque and closer to insolvency, two settings associated with higher bondholder monitoring costs. However, when bondholders have the opportunity to delegate monitoring to senior creditors or to insure against credit losses in the CDS market, they rely less on corporate governance mechanisms. Finally, we document that, consistent with banks being more efficient monitors than bondholders, bank syndicates rely less on corporate governance monitoring unless they have a dispersed ownership.

Keywords: covenants, monitoring cost, delegated monitoring, debt, corporate governance, lender governance

JEL Classification: G34, M10, O16

Suggested Citation

Li, Xi and Tuna, A. Irem and Vasvari, Florin P., Corporate Governance and Covenants in Debt Contracts (April 30, 2014). Available at SSRN: https://ssrn.com/abstract=1988272 or http://dx.doi.org/10.2139/ssrn.1988272

Xi Li (Contact Author)

London School of Economics ( email )

United Kingdom

HOME PAGE: http://www.lse.ac.uk/accounting/facultyAndStaff/profiles/Li.aspx

Ayse Irem Tuna

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom

Florin P. Vasvari

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom

Paper statistics

Downloads
743
Rank
26,858
Abstract Views
3,208