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Corporate governance, covenants restrictiveness and performance pricing in private debt contracts

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posted on 17.02.2017 by Abu Bakar, Intan Suryani
ABSTRACT: This thesis examines the association between corporate governance and the restrictiveness of covenants used in U.S. private debt contracts. Both corporate governance and covenants have been shown to play a role in mitigating agency problems associated with debt. Given their similar monitoring roles, a relationship is expected between these two monitoring mechanisms. Accordingly, it is argued that, ceteris paribus, firms with stronger corporate governance will be perceived by debtholders to be less likely to engage in ex-post opportunism thereby reducing the need to use particularly restrictive covenants. The quality of corporate governance is measured using both a governance index score as well as specific board characteristics such as board independence, directors’ expertise, busyness of directors and CEO duality. Unlike previous research which measures covenants restrictiveness based on rather broad benchmarks such as covenant number and/or an intensity index, this thesis measures restrictiveness based on the tightness of the thresholds around the covenant as proxied by slack. In addition, the thesis investigates the relation between corporate governance and performance pricing, a relatively new contractual feature often included in private debt contracts, in conjunction with covenants. Results from the cross-sectional analysis on a sample of 211 new syndicated loans in the U.S private debt market for the year 2006, indicate that both corporate governance index score and board independence are positively and significantly associated with covenant slack. Similarly, independent directors’ financial expertise and covenants slack are positively related, but there is no evidence to suggest that slack is associated with ‘busy’ directors or CEO duality. There is also no evidence for the predicted relation between corporate governance quality and the likelihood of using performance pricing in debt contracts, but there is a positive relation between corporate governance quality and the use of interest-increasing performance pricing provisions as well as a negative relation between corporate governance quality and the use of a financial ratio as the measure of performance underlying the provisions. Overall, empirical evidence supports the hypothesis that debtholders perceive aspects of corporate governance to be beneficial and it appears they factor them in their contracting decisions. This thesis contributes to the extant literature on the determinants of covenants and performance pricing by providing useful guidance for designing debt contractual terms. Optimally designed contractual terms facilitate effective debt contracting arrangements, thereby leading to a reduction in costs of debt. Since debt represents a major source of funds for most firms, it potentially will have a significant effect on the cost of capital. This thesis is important and useful to both firms and debtholders as it provides valuable insights in dealing with the agency problems associated with debt in more efficient and cost-effective ways.


Campus location


Principal supervisor

George Tanewski

Additional supervisor 1

Paul Mather

Year of Award


Department, School or Centre

Accounting and Finance


Doctor of Philosophy

Degree Type



Faculty of Business and Economics