Amendment Thresholds and Voting Rules in Debt Contracts

Abstract

Most loan contracts in the US contain a provision for lender voting rules. We study the optimal voting rules to modify, waive or renegotiate syndicated loan contracts using an extension of Gârleanu and Zwiebel (2009). In the model, we allow lenders to waive a covenant violation based on a pre-specified voting rule. We show that the optimal voting rule limits lenders’ ability to extract the surplus of profitable projects, thereby improving contracting efficiency. The model predicts that the optimal voting rule is (i) increasing in the agency conflicts within the lending syndicate, and (ii) decreasing in the default risk of the borrower. We test these predictions empirically and find consistent results. Lastly, we extend our model to analyze how the preference for conservative accounting and covenant choices varies with the optimal voting rule. Overall, our results shed light on the economic incentives behind the wide use of voting rules in loan contracts.

Keywords: Debt contracting, voting rule, syndicated loan

JEL Classification: D86, G21, G32, K12, M41