Managerial stock ownership, debt covenants, and the cost of debt

Abstract

This study examines the potential role of managerial ownership in determining the number and types of corporate debt covenants and the effect of debt covenants on the relation between managerial ownership and cost of debt. We find that managerial stock ownership is positively associated with the number of debt covenants, particularly dividend payout and accounting related covenant restrictions. Further investigation shows that the above positive relation is driven by firms with low growth opportunities, suggesting that companies with high managerial stock ownership have incentive to use debt covenants to mitigate managers' opportunities of rent expropriation when agency costs between shareholders and managers are high. Finally, we show that restrictive debt covenants attenuate the positive relation between managerial stock ownership and the yields on newly issued bonds, suggesting that restrictive debt covenants mitigate debtholders' concerns over a closer alignment of interests between managers and shareholders. This study focuses on agency costs related to managerial ownership, which is common in both developed and emerging economies. Future research can also consider the potential effect of the agency costs between controlling and minority shareholders, which is particularly prevalent in emerging economies including the region of the Pacific-Basin.