Bond Covenants and Institutional Blockholding

Abstract

We document a significant and positive effect of institutional block ownership on the number of restrictive bond covenants. This effect is robust to different measures of blockholding and alternative regression models, and it is unlikely to be driven by omitted variables or reserve causality. The positive effect of blockholding on covenants is stronger for active and short-term blockholders, and more pronounced for a group of covenants that are targeted towards shareholder expropriation. These results suggest that covenants are employed ex ante to mitigate incentive conflicts between shareholders and bondholders. Moreover, we find that bond covenants also benefit shareholders by reducing their incremental borrowing costs attributable to agency concerns.

Keywords: Institutional Ownership, Bond Covenants, Bondholder-shareholder Conflicts

JEL Classification: G32, G34