Contractual Strategies and Managerial Opportunism in Leveraged Transactions: Rethinking Unsecured Lending

Abstract

In the ordinary business life of a firm, managers represent the key individuals in charge and responsible for the most relevant company’s corporate governance dynamics. Their drivers and consequent actions directly reflect on the results and the performances the firm managed. As thoroughly evidenced in the literature, the behaviour of certain decision makers may be featured by personal interests and a significant degree of opportunism, aimed at maximizing their personal welfare over shareholders’ or company’s interest. A peculiar form of managerial opportunism have been deeply analysed in terms of agency theory and corporate governance issues arising between managers and shareholders. However, a comprehensive - legal and economic - analysis on the impact of managerial opportunism on the transactions undertaken by the firm with third parties, especially in certain recently developed industries, seems to be still lacking. More in detail, managerial opportunism may have dramatic influences in terms of financing structure and related costs afforded by the firm. On a different standpoint, managerial opportunism shall be taken in proper consideration by the third parties undertaking transactions with the firm, especially when crafting the contractual terms governing such transaction. The bulk of the protections offered to the lender often rely on the use of real security interests, which constitute a guarantee suitable to elevate the ranking of the financier from the usual pari passu principle. However, the availability of security interests it is not always a viable solution, especially where the borrower is not able to provide the lender with a suitable range of assets to rely on, i.e. in early stage company. The present paper will discuss certain selected strategies, other than provisions setting security interests, oriented to minimise the potential harms caused by managerial opportunism in financing transactions between a lender and a corporate borrower. More in detail, an in-depth comment will cover contractual remedies, such as covenants and representations & warranties, and solutions related to the financing structure of the transaction and the related arrangements. Considering the nature of the present work, the scope of the analysis carried out in the following Sections will be mainly referred to one of those industries where the need to address managerial opportunism seems to be even more exacerbated, i.e. the venture capital industry and will focus mainly on privately held companies.