74 Pages Posted: 2 Apr 2016 Last revised: 23 Jun 2017
Date Written: June 21, 2017
Contract theory has stressed the importance of human capital risk associated with management in debt contract design. Using a unique database of private loan contract terms, we find that when this risk is large, lenders include change of management restrictions (CMRs) in loan contracts. These restrictions give lenders explicit control over managerial retention and/or selection decisions. Our analysis also shows that lenders’ interplay with equity holders and the way equity holders (can) contract with management affects lenders’ decision to include a CMR. These results provide two implications that inform the theory: (i) human capital risk associated with management affects debt contracting, but the contracting space is broader than anticipated in existing models, and (ii) shareholders’ role in mitigating or exacerbating human capital risk faced by lenders is important in debt contract design. Finally, we find that the likelihood of CEO turnover more than halved during CMR terms suggesting that these clauses are respected by borrowers and that lenders can influence managerial turnover, even outside of default states.
Keywords: Debt Contracting, Human Capital, Executive Turnover
JEL Classification: D82, G20, G32, G34, J24
Suggested Citation: Suggested Citation