Family firms, debtholder–shareholder agency costs and the use of covenants in private debt

• Published in: Annals of finance Vol. 7; no. 4; pp. 477 - 509
• Main Authors: Bagnoli, Mark, Liu, Hsin-Tsai, Watts, Susan G.
• Format: Journal Article
• Language: English
• Published: Berlin/Heidelberg Springer-Verlag 01-11-2011; Springer Nature B.V
• Subjects: Borrowing; Corporate debt; Corporate finance; Costs; Covenants; Debt; Deficit financing; Economic Theory/Quantitative Economics/Mathematical Methods; Economics and Finance; Equity; Equity stake; Executive compensation; Family owned businesses; Finance; Liquidity; Macroeconomics/Monetary Economics//Financial Economics; Participating loans; Quantitative Finance; Restrictive covenants; Shareholder voting; Stockholders; Studies; Symposium; Voting rights; Agency costs; Family firms; Private debt; G21; G34; Dealscan; Debt covenants; M41
• ISSN: 1614-2446; 1614-2454
• DOI: 10.1007/s10436-009-0127-9

We ask whether the private debt contracts of family firms contain more restrictive covenants tied to accounting numbers than those of non-family firms. Our examination of Dealscan data indicates that credit agreements of Standard and Poor (S&P) 500 family firms are more likely to include accounting-based covenants that limit the lender(s)’ risk that managers will divert cash or assets to shareholders than those of S&P 500 non-family firms. The likelihood is further increased by presence of a dual class stock system that includes supervoting shares. Our results suggest that lenders are more willing to rely on accounting-based covenants to solve the shareholder–private lender agency problem in family firms given that the reporting quality is higher due to better alignment of owner and manager interests in such firms.