Abstract
To answer that question, the following chapter will discuss the potential positive and negative externalities of the bilateral private governance system of covenants. First, it will describe the concept of delegated monitoring, as this theory provides a suitable starting point for analysing potential externalities of a bank’s conduct after a covenant default. Subsequently, the potential positive externalities of providing information as well as a disciplinary effect on the debtor company will be discussed. This will be followed by an examination of the potential negative externalities — namely influencing the debtor company’s management in a way that is not in the interest of all creditors, reducing the pool of assets, and causing unnecessary bankruptcy or a domino effect. Then, the general limits of potential positive or negative externalities due to covenants being based on financial data will be discussed. Finally, the feasibility of positive and negative externalities will be deduced. Overall, the chapter will show that the scale of positive and negative effects mainly depends on the bank’s conduct after a covenant default.
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