Shai Levi is Assistant Professor at Tel Aviv University; Benjamin Segal is Associate Professor at Fordham University; and Dan Segal is Associate Professor of Accounting at the Interdisciplinary Center Herzliya. This post is based on a recent paper by Professors Levi, Segal, and Segal.
Financial reports should provide useful information to both shareholders and creditors, according to U.S. accounting principles. However, directors of corporations have fiduciary duties toward equity holders only. In our paper, Does Fiduciary Duty to Creditors Reduce Debt-Covenant Avoidance Behavior?, we examine whether this slant in corporate governance biases financial reports in favor of equity investors. In particular, we examine whether the likelihood that firms manipulate their reporting to circumvent debt covenants is higher when directors owe fiduciary duties only to equity holders, rather than when they owe fiduciary duties also to creditors. Debt covenants set limits on leverage and performance, and act as a tripwire allowing creditors to take timely actions to reduce bankruptcy risk and costs. When managers manipulate financial reports to circumvent these debt covenants, they transfer wealth from creditors to shareholders.
