Debt Contracting on Management

This paper shows that lenders can influence firms’ governance outside of payment and technical default states by exerting ex-ante control over managerial turnover via retention and selection decisions. Examining private loan agreements, we find 8.5% of firms have change of management restriction (CMR) clauses. CEO turnover analysis suggests CMRs are binding. We find lenders include CMRs to mitigate human capital risk and creditor-shareholder conflicts of interest. CMRs provide a way to contract on soft information and retain management with creditor-friendly style. Finally, CMRs are associated with lower yields, indicating they are in place to protect lenders, not to entrench management.