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Do Creditor Rights Increase Employment Risk?: Evidence from Debt Convenants
Antonio Falato (au); Nellie Liang (au)
This study examines whether financial contracts exacerbate or mitigate agency conflicts among stakeholders. The authors consider a specific contractual provision, debt covenants, and examine how, by allocating control rights between shareholders and debtholders, debt covenants affect the employment relationship. They analyze the role of covenants in both public (bonds) and private (loans) debt contracts. For public debt covenants, they estimate dynamic employment equations and find a significant negative effect of leverage on employment only for firms with relatively high covenant protection. For private debt covenants, the authors use a regression discontinuity design and document sizable job cuts following a covenant violation. Findings suggest that creditor rights increase employment risk and that covenants affect a broader set of operating decisions than previously recognized. Moreover, the results contribute to our understanding of the consequences of the allocation of control rights within the firm by identifying a specific risk-shifting channel from debtholders to employees. Tables. This is a print on demand report.
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