Operating Risk and the Scope of Lender Control Rights

Abstract

When lenders gain control rights in technical default, they influence corporate operating decisions. We develop a novel measure of operational risk-taking that utilizes industry-specific data on corporate operations. Using a regression discontinuity design, we find that borrowers reduce operational risk-taking following covenant violations, corresponding to a marginal decrease in the probability of experiencing distress within one year by as much as 10%. The magnitude of this effect is concentrated in borrowers with ex ante information asymmetry or agency problems and lending syndicates with low coordination costs, low expected loss given default, and high propensity for active intervention.

Keywords: operating risk, technical default, control rights, governance, syndicated loans

JEL Classification: G14, G32, G33, M41