Exogenously Unsecured Creditors and the Pricing and Use of Secured Debt
43 Pages Posted: 17 Jul 2020 Last revised: 15 May 2021
Date Written: May 10, 2021
We use litigation risk disclosures under Regulation S-K to investigate the effectiveness of covenants and security in protecting creditors from dilution from other creditors. We argue that covenants are less effective than collateral at protecting unsecured lenders from dilution arising from litigation and other non-debt related claims; claims we refer to as exogenously unsecured. Consistent with this argument we find that disclosures of litigation claims are associated with a significant increase in the spread between a firm’s secured and unsecured debt claims. More important, we find that the propensity of material litigation claims is negatively related to firms’ reliance on secured debt.
Keywords: Litigation, Debt Structure, Dilution, Priority
JEL Classification: G32, G33
Suggested Citation: Suggested Citation