The Value of Creditor Control in Corporate Bonds

Why are creditor control rights valuable? Control shifts to creditors as the firm becomes distressed, particularly when the firm is closer to default or bankruptcy. From a legal perspective, the fiduciary responsibility of the board shifts to creditors as soon as the firm is in the “zone of insolvency.” Even if the firm is farther from insolvency, cash flow shortfalls such that a firm violates a covenant or misses a scheduled debt payment trigger control rights for debtholders. A natural question that arises is why control should be priced in any security (equity or debt). Theoretically, potential conflicts or disagreements among investors about how to run the firm in a world with incomplete contracts make control valuable. The value of control depends on the probability of a disagreement situation arising and its economic significance, and hence is time varying.