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Co-opted directors, covenant intensity, and covenant violations

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  • Lim, Jesslyn
  • Do, Viet
  • Vu, Tram

Abstract

This study investigates how the level of board co-option might affect a borrowing firm's ex ante covenant intensity and ex post covenant violations. As the fraction of co-opted directors (those who joined the board after the CEO assumed office) increases, creditors include more covenant restrictions in their loan contracts, indicating that more co-opted boards are considered as weaker monitors. The results remain robust to various approaches accounting for endogeneity, and are not driven by alternative explanations such as CEO tenure, director inexperience, or CEO's involvement in the nominating committee. Ex post tests reveal that firms with more co-opted boards are more likely to violate loan covenants after controlling for covenant intensity. Non-co-opted independent directors appear to be the most effective monitors in mitigating covenant violations among revolving loans and loans to unrated borrowers.

Suggested Citation

  • Lim, Jesslyn & Do, Viet & Vu, Tram, 2020. "Co-opted directors, covenant intensity, and covenant violations," Journal of Corporate Finance, Elsevier, vol. 64(C).
    • Handle: RePEc:eee:corfin:v:64:y:2020:i:c:s0929119920300729
    DOI: 10.1016/j.jcorpfin.2020.101628
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    3. Sandvik, Jason, 2020. "Board monitoring, director connections, and credit quality☆," Journal of Corporate Finance, Elsevier, vol. 65(C).
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    More about this item

    Keywords

    Covenant intensity; Covenant violation; Co-opted director; Board monitoring;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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