RFS Advance Access published online on September 30, 2009
Review of Financial Studies, doi:10.1093/rfs/hhp072
Managerial Agency and Bond Covenants
Mays School of Business, Texas A&M University
C. T. Bauer College of Business, University of Houston
C. T. Bauer College of Business, University of Houston
Send correspondence to Praveen Kumar, C. T. Bauer College of Business, University of Houston, Houston, TX 77204-2016; telephone: (713) 743-4770; fax: (713) 743-4789. E-mail: pkumar{at}uh.edu.
JEL Classification: D82, G32, G34
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Abstract |
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Based on an analysis of the agency risk for bondholders from managerial entrenchment and fraud, we derive and test refutable hypotheses about the influence of managerial agency risk on bond covenants, using a comprehensive database of corporate bonds from the 1993–2007 period. Managerial entrenchment and the risk of managerial fraud significantly influence the use of covenants, in the direction predicted by the agency-theoretic framework. Our analysis highlights the varied effects of entrenchment on different types of agency risks faced by bondholders: Entrenched managers aggravate investment risk, but ameliorate risk from shareholder opportunism. Covenant use also responds efficiently to the quality of information available regarding the risk of managerial fraud.
We thank an anonymous referee and the editor, Matt Spiegel, for very helpful comments. We also thank Michael Bradley, Martin Dierker, Yaniv Grinstein, Jean Helwege, Kose John, Dmitry Livdan, Milton Harris, Roni Michaely, Amiyatosh Purnanandam, Latha Ramchand, Michael Roberts, Steve Ross, Sheridan Titman, Stuart Turnbull, and Toni Whited for helpful comments or discussions and Andrew Metrick for providing us with the G index data. We especially thank Annette Poulsen for detailed comments at the WFA (2005) Meetings in Portland.