Working Paper: 2017-08-08
This paper shows that human capital risk associated with management impacts debt contract design, but in ways not anticipated in the literature. We find that lenders can include change of management restrictions (CMRs) giving them explicit control over managerial retention and/or selection decisions. Lenders include CMRs to diminish human capital risk. Shareholders’ role in mitigating or exacerbating human capital risk faced by lenders is an important determinant of CMR inclusion. Additionally, the likelihood of CEO turnover more than halved during CMR terms, suggesting that these clauses are respected and that lenders can influence managerial turnover outside of default states.
Working Paper: 2017-06-01
This paper shows that CEO compensation policies respond to debt contracting. We develop a novel measure of creditor-shareholder disagreement based on the performance metrics used in loan versus compensation contracts. Using a regression discontinuity design around loan covenant violations, we find that violations cause firms to switch toward the class of metrics used by creditors. Additionally, violating firms provide less risk-taking incentives and impose more difficult performance targets. Overall, our results are consistent with compensation contracts serving as commitment devices to decrease the agency cost of debt. They also reveal a channel through which creditors influence corporate governance.
Using risk factors as the unit of disclosure, I show that the managerial decision to add new, retain existing, and remove obsolete risk factors predicts future adverse reporting and real outcomes, providing novel evidence that managers are removing stale disclosures on a timely basis. After controlling for firm-specific heterogeneity, I find that the count of individual risk factors disclosed, rather than an aggregate word count, explains time-series variation in managerial disclosure decisions, consistent with the regulatory intent. I also examine the effect on the disclosure equilibrium by studying managerial response to demand shocks from public and private enforcement actions. The results show that firms respond to investor demand in a manner consistent with the litigation shield hypothesis, and that this effect persists for multiple years. Consistent with the regulatory cost-benefit function, public enforcement does not result in a net increase in disclosed risk factors, but does evoke more definitive disclosures with language that is more specific and an increased use of numbers. Finally, I find that managers provide additional risk factors prior to securities litigation, especially when they are subsequently settled, consistent with supply-side litigation shield effects.