Debt Governance, Credit Spread Dynamics and Managerial Incentives

摘要

Covenants can be viewed as governance mechanism that gives control protection to debtholders. We construct a Covenant Protection Index for a large sample of public bonds and investigate:(1) the impact of covenant protection on the credit spread dynamics; (2) the role of covenant protection in mitigating managerial risk- shifting. We first document that credit spreads are decreasing in the strength of covenant protection. The credit spreads of bonds with minimum and maximum protection can differ by 65 basis points. We conduct novel analysis including a matching technique and other tests to address the issue of endogeneity. Secondly, we study the ex post effectiveness of covenant protection during industry-level and economy-wide negative shocks. Under the exogenous shocks, bonds with strong protection experience signi.cantly less or no value loss. Finally, we document that higher CEO risk-taking incentive (measured by Vega) is associated with higher credit spreads for bonds with weak protection. For bonds with strong protection, higher Vega is associated with lower credit spreads.