Family Firms, Debtholder-Shareholder Agency Costs and the Use of Covenants in Private Debt

Abstract

We ask whether the private debt contracts of family firms contain more restrictive covenants tied to accounting numbers than those of non-family firms. Our examination of Dealscan data indicates that S&P 500 family firms are more likely to include accounting-based covenants that limit the lender(s)' risk that managers will divert cash or assets to shareholders than are S&P 500 non-family firms. The likelihood is further increased by presence of a dual class stock system that includes supervoting shares. This consistent with family firms producing higher quality financial reports (Ali et al. 2007) and with accounting numbers playing an important role in mitigating the possibly severe debtholder-shareholder agency costs when a family firm employs a two-tiered stock structure.

Keywords: Debt covenants, Private Debt, Family Firms, Agency Costs, Debtholder-Shareholder Agency Costs, Dual Class Stock

JEL Classification: G21, G34, M41