Fiduciary Duties and Equity-Debtholder Conflicts

Award Winner: 
Winner of the 2013 Standard Life Investments Finance Prize (Best paper in the Finance Working Paper series)

Fiduciary Duties and Equity-Debtholder Conflicts

Bo Becker, Per Strömberg

Series number :

Serial Number: 

Date posted :

March 01 2012

Last revised :

March 20 2012
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We use an important legal event as a natural experiment to examine the effect of management fiduciary duties on equity-debt conflicts. A 1991 Delaware bankruptcy ruling changed the nature of corporate directors’ fiduciary duties in firms incorporated in that state.

This change limited managers’ incentives to take actions favoring equity over debt for firms in the vicinity of financial distress. We show that this ruling increased the likelihood of equity issues, increased investment, and reduced firm risk, consistent with a decrease in debt-equity conflicts of interest. The changes are isolated to firms relatively closer to default. The ruling was also followed by an increase in average leverage and a reduction in covenant use. Finally, we estimate the welfare implications of this change and find that firm values increased when the rules were introduced. We conclude that managerial fiduciary duties affect equity-bond holder conflicts in a way that is economically important, has impact on ex ante capital structure choices, and affects welfare.

Published in

Published in: 
Publication Title: 
The Review of Financial Studies
Volume 25, Issue 6, 1 June 2012, Pages 1931–1969