Leverage in the Board Room: The Unsung Influence of Private Lenders in Corporate Governance

The influence of banks and other private lenders pervades public companies. From the first day of a lending arrangement, loan covenants and built-in contingency provisions affect managerial decision making. Conventional corporate governance analysis has been slow to notice or account for this lender influence. Corporate governance discourse has traditionally focused only on corporate law arrangements. The few existing accounts of creditors' influence over firm managers emphasize the drastic actions creditors take in extreme cases - when a firm is in serious trouble - but in fact, private lender influence is a routine feature of corporate governance even absent financial distress. While lenders of course intervene when their borrowers encounter distress, recent empirical work demonstrates private lender influence at much earlier points in the debtor-creditor relationship. In addition to the effects of covenant constraints and other initial loan terms, a subsequent covenant violation may trigger active lender intervention, including imposition of additional limits on managerial discretion. Covenant violations and lender intervention, however, do not typically signal the borrower's financial distress. Instead, this interactive response to ex post contingency is routine. Borrower and lender expect future modification of their deal terms, and they contract in anticipation of it. Initial covenants and subsequent violations effectively reallocate degrees of control from managers to lenders, in a fluid process that commences with the inception of the lending arrangement.\nIn this Article, I explain the regularity of lender influence on managerial decision making - "lender governance" - comparing this routine influence to conventional governance arrangements and boards of directors in particular. I show that the extent of private lender influence rivals that of conventional governance mechanisms, and I discuss the doctrinal and policy implications of this unsung influence. Accounting for lender governance requires a new examination of corporate fiduciary duties, debtor-creditor laws, and the regulatory reform proposals that have emerged to address the current financial crisis. I also discuss the implications of private lender influence for future corporate governance research.