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Do creditor rights increase employment risk? evidence from debt covenants

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  • Antonio Falato
  • Nellie Liang
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    Abstract

    This paper studies whether financial contracts exacerbate or mitigate agency conflicts among stakeholders. We consider a specific contractual provision, debt covenants, and examine how, by allocating control rights between shareholders and debtholders, debt covenants affect the employment relationship. We analyze the role of covenants in both public (bonds) and private (loans) debt contracts. For public debt covenants, we estimate dynamic employment equations and find a significant negative effect of leverage on employment only for firms with relatively high covenant protection. For private debt covenants, we use a regression discontinuity design and document sizable job cuts following a covenant violation. Overall, these findings suggest that creditor rights increase employment risk. As such, they complement the recent literature on financial covenants by showing that covenants affect a broader set of operating decisions than previously recognized. Moreover, the results contribute to our understanding of the consequences of the allocation of control rights within the firm by identifying a specific risk-shifting channel from debtholders to employees.

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    Bibliographic Info

    Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2012-42.

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    Date of creation: 2012
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    Handle: RePEc:fip:fedgfe:2012-42

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    Cited by:
    1. Tobias Adrian & Daniel Covitz & Nellie Liang, 2013. "Financial stability monitoring," Finance and Economics Discussion Series 2013-21, Board of Governors of the Federal Reserve System (U.S.).

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