Revise and Resubmit at the Review of Financial Studies
We examine the impact of creditor control rights on corporate acquisitions. Nearly 75% of private credit agreements restrict borrower acquisition decisions. Following a covenant violation, creditors use their bargaining power to tighten these restrictions and limit acquisition activity, particularly deals expected to earn negative announcement returns. Firms that do announce an acquisition while in violation of a covenant earn 1.8% higher stock returns, on average, with the effect concentrated among firms with weak external governance. We conclude that creditors provide valuable corporate governance that benefits shareholders by reducing managerial agency costs.
This paper finds that lenders today rely on less restrictive financial covenants compared to 20 years ago, resulting in a nearly 70% drop in the annual proportion of U.S. public firms reporting a covenant violation. To study this decline, we develop a simple model of optimal covenant design that balances the costs associated with violations that occur when a firm is not in danger of financial distress (“false positives”) with the costs of failing to detect a borrower in danger of financial distress (“false negatives”). We present evidence that lenders have eased the restrictiveness of covenants in ways that greatly reduce the ratio of false positives relative to false negatives, including by switching to covenant packages with higher signal-to-noise ratios.
Prior research argues that universal demand (UD) laws, which weaken shareholders’ litigation rights, incentivize managers to report more and better-quality information. This view relies on post-UD increases in the length and frequency of voluntary disclosure. We find that the increase in disclosure quantity coincides with a decrease in the quality of both voluntary and mandatory disclosure, leading to greater information asymmetry among analysts and in the trading environment. Moreover, managers appear to benefit from the reduced transparency through more profitable insider trades. Therefore, in contrast with prior work, we conclude that corporate information environments deteriorate when shareholder litigation rights decline.
I show that a tariff policy change that increased trade with China led to a decline in U.S. public listing rates and elevated industry concentration. Consistent with heterogeneous firm models of trade, the shock impeded the entry and performance of small manufacturers but did not adversely impact large multinationals. Stock price reactions to the policy change and threat of reversal by President Trump imply that trade liberalization increases the value of large firms and destroys the value of small firms. These findings suggest that globalization contributed to recent trends in the U.S. equity market by disproportionately harming small firms.