Whitehead, Charles K. --- "Creditors and Debt Governance" [2012] ELECD 460; in Hill, A. Claire; McDonnell, H. Brett (eds), "Research Handbook on the Economics of Corporate Law" (Edward Elgar Publishing, 2012)

Book Title: Research Handbook on the Economics of Corporate Law

Editor(s): Hill, A. Claire; McDonnell, H. Brett

Publisher: Edward Elgar Publishing

ISBN (hard cover): 9781848449589

Section: Chapter 5

Section Title: Creditors and Debt Governance

Author(s): Whitehead, Charles K.

Number of pages: 17

Extract:

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 weaken-
ing their incentives and ability to monitor and enforce covenant protections. The 2007­2008
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



1 Portions of this chapter are derived from Whitehead (2009).
2 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 unsec-
...