How to increase the efficiency of bond covenants: a proposal for the Italian corporate market

Abstract

Covenants are particular clauses in the debt contracts of firms that restrict business policy, giving creditors the possibility of putting precise actions into force (normally early repayment) when the covenants are violated. The main purpose of covenants given in the literature is to resolve the conflicts of interest between shareholders and bondholders. Lack of coordination between bondholders may, however, reduce the efficiency of these instruments. We propose an application of the Italian law allowing the insertion of a mandatory representation into the new financial hybrid contracts to give an investment firm the right to act with full power on behalf of the bondholders. We show the impact of this proposal using a formalised example for the issuance of a bond with a covenant for a firm.

The Freeze-Out Bond Exchange Offer: An Experimental Approach

“…Some empirical studies have documented these differences by comparing public and private debt contracts in terms of the number, variety, and restrictiveness of their covenants (Mather and Peirson [2006]). These results have led some authors to search for possible ways to increase the efficiency of bond covenants when the bondholders have a low level of coordination (Amihud et al [2000], Bratton [2006], Bazzana and Palmieri [2012]). …”