0 Creditor Control Rights and Managerial Risk Shifting

Recent evidence shows that corporate policies change significantly following covenant violations. These changes are attributed to increased creditor influence over firms in ways benefiting both shareholders and debtholders. I find that the expected negative relation between volatility and investment reverses at violations, consistent with risk-shifting. This behavior is more pronounced in firms with high vega CEOs and high CEO equity ownership. Moreover, firm risk significantly increases following violations. These findings suggest that even in the presence of increased creditor control risk-shifting still occurs. The prior conclusions that shareholder-debtholder incentives are congruent at violations do not appear to be the case