Essays on lenders' dual ownership of debt and equity

Abstract

Lenders' simultaneous debt and equity holdings (hereafter as "dual ownership") mitigate the conflicts of interest between creditors and shareholders, enhance the creditors' monitoring of the borrowing firm, reduce the agency costs of debt, and, on the other hand, increase the creditors' exposure risk due to the loss of diversification. The thesis investigates the effect of dual ownership on loan contracting, subsequent corporate investment, and debt renegotiation following covenant violations. In the first essay, using a sample of loan agreements signed by non-financial public firms in the U.S. during the period 1996-2010, I examine the impact of creditors' simultaneous debt and equity holdings on loan contracting and corporate investment decisions. I find that the presence of dual ownership reduces the likelihood of having a capital expenditure restriction covenant in the loan contract by about one-quarter relative to the sample mean. This effect is concentrated in borrowers of lower creditworthiness and less visibility and in non-commercial bank lenders that have more incentives to monitor. Extensive robustness checks, including firm fixed-effect estimation, change regressions, and instrumental variable estimation, show that the negative effect of dual ownership is unlikely to be driven by endogeneity. I also find that dual ownership plays a governance role in reducing managerial overinvestment but mitigates the decline in investment in the recent financial crisis. There is no evidence on the association between the presence of dual ownership and the borrower's future abnormal stock return, and share ownership by creditors does not appear to improve the borrower's investment efficiency. In the second essay, using a sample of U.S. non-financial firms, I present evidence that creditors' equity ownership in the borrowing firm has important bearings on debt renegotiation and the financing and investment policies following financial covenant violations. I find that firms with dual ownership are more likely to be granted a waiver after technical defaults, consistent with the more effective monitoring and the alignment of interest between creditors and borrowers that are afforded by dual ownership. In connection with recent research showing that firms experience a sharp decline in investment and net debt financing following covenant violations, my results suggest that the presence of dual ownership mitigates the adverse effect of covenant violations on firms' financing and investment activities. This study complements the findings on creditors' role in debt renegotiation and corporate financial policies.

Date of Award	2 Oct 2013
Original language	English
Awarding Institution	City University of Hong Kong
Supervisor	Hong Joe ZOU (Supervisor)