Estimating the Cost of Control Rights in the Corporate Loan Market

Abstract

Financial covenants transfer control rights to lenders when borrowers’ metrics breach pre-set thresholds. Contingent control rights allow lenders to extract monetary concessions (e.g., fees and renegotiation) and behavioral concessions (e.g., CEO turnover and reduced investment, R&D, and payroll). We develop a simple theoretical framework to estimate the cost of control, which we find to be 52.7 basis points. On average, control payments correspond to a 14.8% discount on the total cost of borrowing (Berg, Steffen, and Saunders 2016). This finding has implications for our understanding of loan pricing and the value of control rights in the private loan market.

Keywords: syndicated lending, financial covenants, control rights, loan pricing

JEL Classification: G21, G32, K12, L14, E32, E44