Blocking Block-Formation: Evidence from Private Loan Contracts

Abstract

Capital covenants in credit agreements mitigate agency problems by aligning creditor-shareholder interests. By investigating change in control (CIC) clauses, this paper shows that the way equity capital is distributed and potential conflicts of interest among shareholders also matter to lenders. Examining 14,940 private loan contracts, we document significant heterogeneity in CIC clauses. Specifically, CICs include equity ownership caps, which limit large equity block formation, with high variation in cap thresholds. Lenders set lower caps to mitigate risks arising from activism, takeovers, within-syndicate coordination costs, and power contests among shareholders. Caps below 50% are associated with a drop in firm value but not in the cost of debt, indicating exacerbated firm-manager agency costs. Finally, these caps are associated with changes in buyback policies and largest block size, suggesting new ways creditors may influence corporate governance.

Keywords: Equity Block Formation, Change in Control, Debt Contracting

JEL Classification: G20, G32, G34