Blocking Block-Formation: Evidence from Private Loan Contracts

Abstract

Change in control clauses are pervasive in loan contracts, yet their terms are not boilerplate. Examining 14,940 contracts, we document significant heterogeneity in the use and size of ownership caps, which limit large equity block-formation. Lenders set lower caps to mitigate risks arising from power contests among shareholders, activism and takeover threats, and within-syndicate coordination costs. We confirm some of these effects using two quasi-natural experiments. Setting caps below 50% is associated with a drop in firm value, but not in the cost of debt, consistent with exacerbated firm-manager agency costs. Finally, largest block size increases when these restrictions expire and the likelihood of withdrawing an announced buyback increases during the life of the loan, shedding new light on ways creditors may influence corporate governance.

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

JEL Classification: G20, G32, G34