State Contract Law and Debt Contracting

• In Event: Debt contracting
  In Paper Session: Debt Contracting

Abstract

We examine the relation between debt contracting and state contract law. We find that when the contract is governed by law that is favorable to lenders (pro-lender law), there are significantly fewer covenant violations than when the contract is governed by law that is favorable to debtors (pro-debtor law). We also find that the costs of covenant violations are complementary with the governing law. When a contract is governed by pro-debtor law, the costs of covenant violations---such as reductions in net debt issuance, acquisitions, capital expenditures, and physical property, as well as increases in the number of covenants---either do not occur or occur in much smaller magnitude. Finally, we compare contract terms and firm characteristics by state of contracting. The data suggest that firms opt into the governing law that is best suited for their needs, providing support for the legal argument that there is a market for contracts similar to the market for incorporations.

Authors

• Colleen Honigsberg, Columbia University

• Sharon P Katz, Columbia University

• Gil Sadka, Columbia University