Senior Lender Control: Monitoring Spillover or Creditor Conflict?

Abstract

This paper studies the effect of senior lender control, as measured by bank loan covenants, on the pricing of new bond issues. We find a U-shaped relation between the number of financial covenants on a firm’s loan contract and the bond yield spread. Our results suggest that bondholders initially value the monitoring benefits derived from loan covenants; as lender control becomes excessive, however, bondholders require compensation for the risk of losses due to creditor conflicts. Our heterogeneity tests show that the positive relation between bond yield and loan covenants is stronger when bondholding is more dispersed but is weaker for firms with lower default risk or weaker corporate governance as well as in the presence of relationship lenders.

Keywords: delegated monitoring, creditor conflict, lender control rights, loan covenants, corporate bonds

JEL Classification: G30, G33, G34