Stakeholder orientation and the tightness of bank loan covenants

Our research explores the impact of stakeholder orientation on the tightness of bank loan covenants. To study this, we leverage a quasi-experimental scenario arising from the phased implementation of constituency statutes in the United States to conduct our investigation. These statutes offer managers a legal instrument to shield the interests of stakeholders other than shareholders. Employing a difference-in-differences approach, our analysis indicates a substantial relaxation in the strictness of loan covenants for companies established in states that have constituency statutes. Furthermore, cross-sectional tests indicate that covenant strictness decreases more when there is higher information asymmetry or when there is a lack of observable signals for creditors, customers, suppliers, and employees to gauge the firm's future prospects of expropriation. Our findings indicate that the reduction of information asymmetry plays a more dominant role than the mitigation of agency conflicts in explaining the observed changes. Additionally, when we consider the overall terms of loan contracts, the enforcement of these statutes has a greater influence on loan covenants than on loan spread.