How Laws Affect Contracts: Evidence from Yankee Bond Covenants
We examine how country-level legal and institutional differences in creditor and shareholder rights shape the use of bond covenants. Using comprehensive debt covenant information for a sample of Yankee bonds issued by firms from more than 50 countries, we find that bond contracts for firms incorporated in countries with stronger creditor rights use fewer restrictive covenants. This finding suggests that creditor rights laws substitute for debt covenants in reducing the agency cost of debt. On the other hand, bond contracts for firms incorporated in legal regimes with stronger shareholder rights include more covenants, suggesting that greater shareholder rights may actually increase the shareholder-bondholder agency conflict. These results are robust to alternative measures of creditor rights and shareholder rights. We also document that stronger firm-level corporate governance is positively related to the use of restrictive covenants even after controlling for country institutions.
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