Borrower Managerial Discretion and Covenant-Lite Loans

In syndicated loan markets, one striking development in leveraged loan segment is the emergence of a borrower-flexible loan type, called covenant-lite loans in which maintenance covenants are excluded ex-ante. Prior studies look at reasons for lenders to accept this type of loans and document surge of covenant-lite loans is to reduce renegotiation costs and to eliminate renegotiation fictions due to widespread lender-base. The purpose of this paper is to analyze, from the borrowers’ side, whether and how managerial discretion may impact managerial acceptance of this borrower-flexible loan type. I measure managerial discretion from two different dimensions. The incentive to pursue personal interests is measured by managerial opportunism incentives, and the incentive to pursue business interests is measured by managerial flexibility incentives. Empirical results show both managerial incentives play a significant role in propensity to borrow covenant-lite loans, but managerial opportunism incentives significantly dominate managerial flexibility incentives suggesting stronger executive power base being more likely to borrower-flexible loan contracts. Furthermore, managerial flexibility incentives are decomposed into organizational discretion and environmental discretion. Organizational discretion describes a need for managerial flexibility due to firm-specific uncertainty. In exchange for organizational discretion, borrowers pay higher loan spread and accept tighter loan strictness to compensate the lenders.