The Economics of Covenants as a Means of Efficient Creditor Protection

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 th...

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Bibliographic Details
Published inEuropean business organization law review Vol. 7; no. 1; pp. 89 - 94
Main Author Schmidt, Klaus M.
Format Journal Article
LanguageEnglish
Published The Hague, NL T.M.C. Asser Press 01.03.2006
Springer Nature B.V
Subjects
Bankruptcy
Cash flow
Collective action
Commercial law
Corporate finance
Covenants
Creditors
Debt
Economics
Investments
Stockholders
Studies
agency costs of debt
creditor protection
renegotiation
Covenants
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Summary: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.
ISSN:1566-7529
1741-6205
DOI:10.1017/S1566752906000899