Shareholders, Creditors, and Directors' Fiduciary Duties: A Law and Finance Approach

52 Pages Posted: 4 Jul 2007

See all articles by Remus D. Valsan

Remus D. Valsan

McGill University - Faculty of Law

Moin A. Yahya

University of Alberta - Faculty of Law

Multiple version iconThere are 2 versions of this paper

Abstract

The debate surrounding fiduciary duties owed to creditors by directors, especially in the vicinity of insolvency, has resurfaced in light of two court decisions in Canada and the United States. In this paper, we contribute to the discussion by looking at the issue from a corporate finance perspective, where we utilize well-established theorems and results. We show that creditors are able to protect themselves by the use of covenants. While this idea has been reported extensively in previous discussions about fiduciary duties, we focus on studies that show the extent to which creditors use covenants to protect themselves against opportunistic behavior by managers and shareholders. Additionally, we show that debt can actually increase the value of the firm and the shares, and therefore, the idea that shareholders use debt for opportunistic behavior is misplaced. If anything, debt is used to align managerial incentives to maximize the value of the firm. The Fisher Separation theorem is also introduced and used to show that all stakeholders in a firm will want the firm to pursue projects with the maximum net present value. Hence, we propose that fiduciary duties should always be owed to the corporation as a whole, where the main focus of the managers is investing in those projects that have the highest expected net present value.

Keywords: Fiduciary Duties, Corporate Governance, Finance, Law and Economics

JEL Classification: G32, G31, K22

Suggested Citation

Valsan, Remus D. and Yahya, Moin A., Shareholders, Creditors, and Directors' Fiduciary Duties: A Law and Finance Approach. Virginia Law & Business Review Vol. 2, No. 1, 2007, Available at SSRN: https://ssrn.com/abstract=998165

Remus D. Valsan (Contact Author)

McGill University - Faculty of Law ( email )

3644 Peel Street
Montreal H3A 1W9, Quebec
Canada

Moin A. Yahya

University of Alberta - Faculty of Law ( email )

Edmonton, Alberta T6G 2H5
Canada
780-492-4445 (Phone)
780-492-4924 (Fax)

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