Litigation Risk and Debt Structure Choice

44 Pages Posted: 17 Jul 2020 Last revised: 22 Jun 2022

See all articles by Dominique C. Badoer

Dominique C. Badoer

University of Illinois at Chicago - Department of Finance

Mustafa Emin

Tulane University

Christopher M. James

University of Florida - Department of Finance, Insurance and Real Estate

Date Written: May 10, 2021

Abstract

We investigate the effectiveness of security in protecting creditors from dilution arising from litigation and other non-debt related claims; claims we refer to as exogenously unsecured. Consistent with this security affording greater protection from dilution, we find that disclosures of litigation claims are associated with a significant increase in the spread between a firm’s unsecured and secured and debt claims. More important, we find that the propensity of material litigation claims is negatively related to firms’ reliance on secured debt. Our findings are consistent with the notion that collateral provides protection from litigation claims, and thus is an additional motivation for firms to borrow on a secured basis, even in circumstances where covenants on unsecured claims might be effective in mitigating the agency costs of debt.

Keywords: Litigation, Debt Structure, Dilution, Priority

JEL Classification: G32, G33

Suggested Citation

Badoer, Dominique C. and Emin, Mustafa and James, Christopher M., Litigation Risk and Debt Structure Choice (May 10, 2021). Available at SSRN: https://ssrn.com/abstract=3623436 or http://dx.doi.org/10.2139/ssrn.3623436

Dominique C. Badoer (Contact Author)

University of Illinois at Chicago - Department of Finance ( email )

2431 University Hall (UH)
601 S. Morgan Street
Chicago, IL 60607-7124
United States

Mustafa Emin

Tulane University ( email )

1440 Canal St.
NEW ORLEANS, LA 70112

Christopher M. James

University of Florida - Department of Finance, Insurance and Real Estate ( email )

P.O. Box 117168
Gainesville, FL 32611-7168
United States
352-392-3486 (Phone)
352-392-0301 (Fax)

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