Does Social Trust Affect International Contracting? Evidence from Foreign Bond Covenants

Abstract

This paper investigates the influence of social trust on security-level contract design. Using a sample of non-U.S. firms issuing bonds in U.S. debt markets, we find that U.S.-based creditors impose fewer covenants on bond issuers domiciled in countries with a high degree of social trust. We further show that the inverse relation between social trust and debt covenants is more pronounced for firms from countries with weak institutions, for firms with poor corporate governance, and for more opaque firms. These findings are robust to endogeneity tests, within-country analysis, and alternative empirical models, measures of trust, and explanations. We also find that a higher level of social trust is associated with lower borrowing costs, but this relation weakens when covenants are included in the debt contract.

Keywords: Trust; Contracts; Covenants; Institutions; Corporate Governance

JEL Classification: F30; G30; M41