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Leverage in the Board Room: The Unsung Influence of Private Lenders in Corporate Governance

Leverage in the Board Room: The Unsung Influence of Private Lenders in Corporate Governance. Forthcoming 57 UCLA L. Rev. __ (2009). Frederick Tung Emory University School of Law. Law and New Institutional Economics Workshop University of Colorado Law School June 5, 2009.

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Leverage in the Board Room: The Unsung Influence of Private Lenders in Corporate Governance

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  1. Leverage in the Board Room:The Unsung Influence of Private Lenders in Corporate Governance Forthcoming 57 UCLA L. Rev. __ (2009) Frederick Tung Emory University School of Law Law and New Institutional Economics WorkshopUniversity of Colorado Law SchoolJune 5, 2009

  2. Leverage in the Board Room I. Background II. The Dynamics of Leverage III. The Limits of Lender Governance IV. Implications

  3. I. Background A. Traditional Corporate Governance: Agency Costs and Corporate Law Corporate law shareholders the corporation Board of directors  B A C K G R O U N D Agency costs officers Other employees 2

  4. I. Background A. Traditional Corporate Governance: Agency Costs and Corporate Law B. Bank Governance: Finance Bank are special. Law  Distress-induced creditor intervention. • Triantis & Daniels ’95: Interactive stakeholder governance. • Baird & Rasmussen ’06:Covenants shift control to private lenders. • Shepherd, Tung & Yoon ’08: Bank monitoring  improved firm value.  B A C K G R O U N D 2

  5. I. Background C. Structure of Lender Governance 1. Covenants 2. Reporting and Access 3. Institutional Practices S T R U C T U R E 3

  6. I. Background C. Structure of Lender Governance Financial Investment constraints Fundamental changes 1. Covenants 2. Reporting and Access 3. Institutional Practices S T R U C T U R E 3

  7. I. Background C. Structure of Lender Governance Periodic financial reports Certifications Access to books and records, management and accountants 1. Covenants 2. Reporting and Access 3. Institutional Practices S T R U C T U R E 3

  8. I. Background C. Structure of Lender Governance 1. Covenants 2. Reporting and Access 3. Institutional Practices Bankers on board Cash management Short maturities S T R U C T U R E 3

  9. I. Background D. Compare Traditional Governance Mechanisms:  B A C K G R O U N D 2

  10. I. Background & Framework D. Compare Traditional Governance Mechanisms:  B A C K G R O U N D 2

  11. II. The Dynamics of Leverage A. Durable Banking Relationships & Renegotiation B. Stages of Lender Influence: Covenants, Contingencies, & Violations C. Operational Consequences D Y N A M I C S O F L E V E R A G E 3

  12. II. The Dynamics of Leverage A. Durable Banking Relationships & Renegotiation • Renegotiation is the norm. • 90% > 1 year • 96% > 3 years • 44% of original term • Major changes to fundamental terms. Loan term • maturity • loan amount • interest spread D Y N A M I C S O F L E V E R A G E Avg. change 64% 43% 40% 3

  13. II. The Dynamics of Leverage A. Durable Banking Relationships & Renegotiation • Renegotiation rarely causes change in lender. D Y N A M I C S O F L E V E R A G E 3

  14. II. The Dynamics of Leverage B. Stages of Lender Influence: Covenants, Contingencies, & Violations • Performance pricing • Violations very common. D Y N A M I C S O F L E V E R A G E 3

  15. II. The Dynamics of Leverage B. Stages of Lender Influence: Covenants, Contingencies, & Violations • Financial policy (>90%) • Net borrowing drops by 105 basis points following violation (75th to 35th %-ile) • Investment policy (33-40%) • 15-20% greater decline with initial covenant • Imposition very sensitive to firm performance • Forced CEO turnover • Much more sensitive to firm performance with bank debt — 25-46% greater likelihood — 67-90% greater likelihood if also violation D Y N A M I C S O F L E V E R A G E 3

  16. II. The Dynamics of Leverage C. Operational Consequences D Y N A M I C S O F L E V E R A G E 3

  17. III. Limits of Lender Governance Market Effects A. Liquidity B. Risk Transfer Syndication Secondary loan markets Credit derivatives L I M I T S 3

  18. IV. Implications A. Governance spillovers from regulation of creditors and credit markets. a. Debtor-creditor law b. Financial regulation: CDS markets B. Is lender governance efficient? . . . and other directions for corporate governance research. I M P L I C A T I O N S 3

  19. Leverage in the Board Room:The Unsung Influence of Private Lenders in Corporate Governance Frederick Tung Emory University School of Law Law and New Institutional Economics WorkshopUniversity of Colorado Law SchoolJune 5, 2009

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