Creditor control rights and borrower protection: the role of borrower consent clause in private debt contracts

Saiying Deng () and Yutao Li ()
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Saiying Deng: Kent State University
Yutao Li: University of Lethbridge

Review of Quantitative Finance and Accounting, 2023, vol. 61, issue 1, No 11, 357-394

Abstract: Abstract We investigate how borrower consent clause (BCC) is used in private debt contracts as a contract design mechanism to protect borrower interests. We find that the probability of including a BCC in debt contracts increases in the intensity of creditor control rights measured by number of financial covenants. Furthermore, we document that performance covenants result in higher likelihood of BCC inclusion than capital covenants do. For robustness checks, we use alternative proxies for creditor control rights, and employ simultaneous equation and propensity score matching to address endogeneity. The baseline results still hold. Exploiting Anti-Recharacterization Law (ARL) as a quasi-natural experiment for strengthened creditor rights, we find that adoption of ARL increases the likelihood of BCC inclusion. Using credit default swap (CDS) trading as a setting of weakened creditor control rights, we document the inception of CDS trading is associated with lower likelihood of including BCC. Furthermore, we find that the association between creditor control rights and BCC is more pronounced for borrowing firms with good quality and more conservative financial reporting.

Keywords: Borrower consent clause; Creditor control rights; Loan assignment; Incomplete contracting (search for similar items in EconPapers)
JEL-codes: G21 G30 L14 (search for similar items in EconPapers)
Date: 2023
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DOI: 10.1007/s11156-023-01151-6

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