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Does fiduciary duty to creditors reduce debt-covenant-violation avoidance behavior?

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Levi, Shai, Segal, Benjamin and Segal, Dan (2021) Does fiduciary duty to creditors reduce debt-covenant-violation avoidance behavior? Journal of Business Finance and Accounting, 48 (5-6). pp. 929-953. doi:10.1111/jbfa.12509

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Official URL: https://doi.org/10.1111/jbfa.12509

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Abstract

Financial reports should provide useful information to shareholders and creditors. Directors, however, normally owe fiduciary duties to equity holders, not creditors. We examine whether this slant in fiduciary duties affects the extent to which firms use financial engineering to circumvent debt covenants violation. By avoiding debt covenants violation, firms prevent creditors from taking actions to reduce bankruptcy risk and recover their investment, and allow the firm to continue operating for the benefit of equity holders. We find that a Delaware court ruling that imposed fiduciary duties toward creditors led to a decrease in financial engineering and debt‐covenant avoidance in Delaware firms. We also show that board quality lowers financial engineering and debt‐covenant avoidance by firms only when their directors owe a legal fiduciary duty to creditors. Collectively, our results suggest that unless directors are required to protect creditors’ interest, they are likely to take actions to circumvent debt covenant violations.

Item Type: Journal Article
Subjects: H Social Sciences > HD Industries. Land use. Labor
H Social Sciences > HF Commerce
H Social Sciences > HG Finance
Divisions: Faculty of Social Sciences > Warwick Business School
Library of Congress Subject Headings (LCSH): Debt service , Financial statements , Trusts and trustees, Corporate governance
Journal or Publication Title: Journal of Business Finance and Accounting
Publisher: Wiley-Blackwell Publishing Ltd.
ISSN: 0306-686X
Official Date: May 2021
Dates:
DateEvent
May 2021Published
16 November 2020Available
13 October 2020Accepted
Volume: 48
Number: 5-6
Page Range: pp. 929-953
DOI: 10.1111/jbfa.12509
Institution: University of Warwick
Status: Peer Reviewed
Publication Status: Published
Publisher Statement: "This is the peer reviewed version of the following article: Levi, S., Segal, B. and Segal, D. (2020), Does fiduciary duty to creditors reduce debt‐covenant‐violation avoidance behavior?. J Bus Fin Acc. Accepted Author Manuscript. , which has been published in final form at https://doi.org/10.1111/jbfa.12509. This article may be used for non-commercial purposes in accordance with Wiley Terms and Conditions for Use of Self-Archived Versions."
Access rights to Published version: Restricted or Subscription Access
RIOXX Funder/Project Grant:
Project/Grant IDRIOXX Funder NameFunder ID
UNSPECIFIEDMordechai ZagagiUNSPECIFIED
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