Edited by Claire A. Hill and Brett H. McDonnell
Chapter 5: Creditors and Debt Governance
Charles K. Whitehead 1. INTRODUCTION1 Most corporate debt is private, and most private lenders are banks (although increasingly they include non-bank lenders) (Kahan & Tuckman 1993; Amihud et al. 1999; Wilmarth 2002).2 Even among public firms, which typically have access to larger pools of capital, roughly 80% maintain private credit agreements (Nini et al. 2009). Consequently, debt’s role in corporate governance (sometimes referred to as ‘debt governance’) has mirrored changes in the private credit market.3 Within the traditional framing, bank lenders tend to rely on covenants and monitoring as the most cost-effective means to minimize agency costs and manage a borrower’s credit risk.4 Loans were historically illiquid, and so lenders had a direct and long-term say in how a firm was managed. As liquidity increased, banks began to manage credit risk through purchases and sales of loans and other credit exposure, lowering capital costs, but potentially weakening their incentives and ability to monitor and enforce covenant protections. The 2007–2008 financial crisis – and recognition that shareholder oversight, without the offsetting discipline provided by creditors, could cause financial firms to incur socially suboptimal levels of risk5 – re-focused attention on the importance of debt governance.6 Portions of this chapter are derived from Whitehead (2009). Many firms use both public and private sources of debt capital, including bank debt, program debt (such as commercial paper), and public bonds. Investment-grade firms often rely on senior unsecured debt and equity, while lower-credit firms are more likely to rely on a combination of secured bank debt,...
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