Working Paper: NBER ID: w17661
Authors: Bo Becker; Per Strömberg
Abstract: We use an important legal event as a natural experiment to examine the effect of management fiduciary duties on equity-debt conflicts. A 1991 Delaware bankruptcy ruling changed the nature of corporate directors' fiduciary duties in firms incorporated in that state. This change limited managers' incentives to take actions favoring equity over debt for firms in the vicinity of financial distress. We show that this ruling increased the likelihood of equity issues, increased investment, and reduced firm risk, consistent with a decrease in debt-equity conflicts of interest. The changes are isolated to firms relatively closer to default. The ruling was also followed by an increase in average leverage and a reduction in covenant use. Finally, we estimate the welfare implications of this change and find that firm values increased when the rules were introduced. We conclude that managerial fiduciary duties affect equity-bond holder conflicts in a way that is economically important, has impact on ex ante capital structure choices, and affects welfare.
Keywords: fiduciary duties; equity-debt conflicts; natural experiment; corporate governance; financial distress
JEL Codes: G32; G33; H1; H10; L2
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Credit Lyonnais ruling (G33) | increased equity issuance for Delaware firms close to financial distress (G33) |
| Credit Lyonnais ruling (G33) | reduced debt overhang problem (F34) |
| Credit Lyonnais ruling (G33) | decreased volatility of returns on assets (ROA) for high-leverage firms (G32) |
| Credit Lyonnais ruling (G33) | decreased risk-shifting behavior by equityholders (G34) |
| Credit Lyonnais ruling (G33) | decreased cost of debt (G32) |
| Credit Lyonnais ruling (G33) | diminished use of covenants in new debt issues (G33) |