The Economics of Covenants as a Means of Efficient Creditor Protection

Posted: 19 Feb 2007

See all articles by Klaus M. Schmidt

Klaus M. Schmidt

Ludwig Maximilian University of Munich (LMU) - Faculty of Economics; CESifo (Center for Economic Studies and Ifo Institute); Centre for Economic Policy Research (CEPR)

Abstract

Covenants are a means to mitigate the agency problems between borrower and lender that are induced by the allocation of cash flow rights in a debt contract. This comment shows that if covenants could be renegotiated without any transaction costs they could be used to induce efficient behaviour on the part of the borrower and to fully protect lenders. Due to problems of asymmetric information, collective action and hold-up, however, covenants are imperfect. The analysis suggests several ways to improve the functioning of covenants.

Keywords: covenants, creditor protection, agency costs of debt, renegotiation

JEL Classification: K20

Suggested Citation

Schmidt, Klaus M., The Economics of Covenants as a Means of Efficient Creditor Protection. European Business Organization Law Review (EBOR), Vol. 7, 2006 . Available at SSRN: https://ssrn.com/abstract=963326

Klaus M. Schmidt (Contact Author)

Ludwig Maximilian University of Munich (LMU) - Faculty of Economics ( email )

Ludwigstrasse 28
Munich, D-80539
Germany
+49 89 2180 3405 (Phone)
+49 89 2180 3510 (Fax)

CESifo (Center for Economic Studies and Ifo Institute)

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Munich, DE-81679
Germany

HOME PAGE: http://www.CESifo.de

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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