State Contract Law and Debt Contracting
Coauthor(s): Colleen Honigsberg, Gil Sadka.
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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
violationssuch as reductions in net debt issuance, acquisitions, capital expenditures, and physical property, as well as increases in the number of covenantseither 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.
Honigsberg, Coleen, Sharon Katz, and Gil Sadka. "State Contract Law and Debt Contracting." Columbia Business School, 2013.