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How legal environments affect the use of bond covenants

Author

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  • Yaxuan Qi

    (Department of Finance, John Molson School of Business, Concordia University, Montreal, Canada)

  • Lukas Roth

    (Department of Finance and Management Science, Alberta School of Business, University of Alberta, Edmonton, Canada)

  • John K Wald

    (Department of Finance, College of Business, University of Texas at San Antonio, San Antonio, USA)

Abstract

We examine how country-level legal and institutional investor protection shapes contractual creditor protection. We examine debt covenant information from foreign corporate bonds issued in the US from more than 50 countries between 1991 and 2007. We find that bonds of firms incorporated in countries with stronger creditor rights use fewer covenants. This finding suggests that creditor protection substitutes for covenants in reducing the agency cost of debt. In contrast, bonds of firms with stronger shareholder rights or firms with stronger firm-level corporate governance use more covenants. These findings support the notion that firms with stronger shareholder control may face an increase in the shareholder–bondholder conflict and therefore prefer to use more covenants. However, greater shareholder rights are not associated with the use of more covenant restrictions on equity issuance, as firms with greater minority shareholder protection are unlikely to suffer such equity dilution.

Suggested Citation

  • Yaxuan Qi & Lukas Roth & John K Wald, 2011. "How legal environments affect the use of bond covenants," Journal of International Business Studies, Palgrave Macmillan;Academy of International Business, vol. 42(2), pages 235-262, February.
    • Handle: RePEc:pal:jintbs:v:42:y:2011:i:2:p:235-262
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