Debt as Corporate Governance

Corporate law is dominated by an equity-only view of corporate governance that centers on management-shareholder dynamics. This Article expands the management-shareholder paradigm by developing a novel integrated theory of corporate governance that fully accounts for the firm’s debt. To that end, the Article carries out a comprehensive analysis of debtholders’ influence on how the firm runs its affairs. This analysis reveals that debt does not merely function as a discipliner. Rather, debt forms an integral part of the ownership and governance structure of the firm through the covenants that debtholders routinely contract for. These covenants create poison pills and other change-of-control and board restrictions, as well as restrictions on debt incurrence, asset transfers, and cash transfers such as dividends. Armed with these covenants, and the default and refinancing costs the covenants impose on the firm, the debtholders control the firm’s operations and management along several dimensions.

This Article develops the theoretical underpinnings of debt as corporate governance and then moves on to map out the standard debt covenants and their effect on the firm. Building on this integrated account, this Article updates the narrow equity-only view of the firm and demonstrates that perceiving corporate debt mechanisms as a governance system advances our understanding of pressing issues such as corporate social responsibility, interstate and federal corporate law competition, and the role of institutional investors.