Electronic copy of this paper is available at: http://ssrn.com/abstract=981747

Family Firms, Debtholder-Shareholder Agency Costs and the Use of Covenants in Private Debt

by

Mark Bagnoli

Hsin-Tsai Liu

Susan G. Watts

Krannert School of Management Purdue University

West Lafayette, IN 47907-2056

March 2007

We thank Jason Abrevaya, Jennifer Altamuro, Anil Arya, John Fellingham, Chris Hogan, Marilyn Johnson, Rick Johnston, Yinghua Li, Scott Liao, Sam Pae, K. Ramesh, Doug Schroeder, Karen Sedatole, Eric Spires, Dave Williams, Rick Young, Helen Zhang, and workshop participants at Michigan State University, Ohio State University and the BKD Brown Bag Workshop at Purdue for many very helpful discussions, comments and suggestions. Bagnoli and Watts gratefully acknowledge the financial support of the Krannert School of Management and Purdue University.

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Electronic copy of this paper is available at: http://ssrn.com/abstract=981747

Family Firms, Debtholder-Shareholder Agency Costs

and the Use of Covenants in Private Debt

Abstract

We ask whether the unusually close alignment of manager and shareholder interests in family firms is associated with increased use of restrictive covenants in private debt contracts. Our examination of Dealscan data indicates that S&P 500 family firms are more likely to include accounting-based covenants that limit the lender(s)’ risk that managers will divert cash or assets to shareholders than are S&P 500 non-family firms. The likelihood is further increased by presence of a dual class stock system that includes supervoting shares. This suggests that accounting numbers play an important role in mitigating debtholder-shareholder agency costs in family firms.

JEL codes: G21, M41 Keywords: Debt covenants, Dealscan, Family Firms

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1. Introduction.

Recent research indicates that family firms (companies in which the founders or their

families exert significant influence through either their equity stake in the firm and/or

their presence in senior management and/or on the board of directors) are surprisingly

common. LaPorta et al. (1999), Claessens et al. (2000), and Faccio and Lang (2002) show

that family firms are at least as prevalent as non-family firms in Europe and Asia, and

Anderson and Reeb (2003a) report that in the U.S., one-third of Standard and Poor’s

(S&P) 500 firms can be classified as family firms. Further, Anderson and Reeb (2003a)

provide evidence that family members tend to have a significant equity stake in their

firms: On average, family members hold approximately 19% of their company’s shares.

To date, accounting researchers have focused on the impact of founding family

ownership structure on shareholder-shareholder conflicts by studying how it affects the

incentive to manipulate earnings (Ali et al. 2007, Wang 2006), and the way in which

executive compensation contracts are tied to accounting numbers (Chen 2005). Finance

researchers have focused on its impact on firm performance (e.g., Anderson and Reeb

2003a, Bennedsen et al. 2006, Villalonga and Amit 2006) and the cost of public debt

(Anderson et al. 2003, Ellul et al. 2005). In this paper, we contribute to this literature by

focusing on the debtholder-shareholder conflict in family firms and its effect on the use

of financial covenants in private bank loans. Because we examine covenants that rely on

accounting numbers, our paper contributes to the accounting literature in particular by

assessing the usefulness of financial statement information in private debt contracting

between family firms and their lenders.

We focus on the use of covenants in private loan agreements for two reasons. First,

private loans dominate the market for corporate debt. Dichev and Skinner (2002) report

that private debt represents 80% of funded debt for their sample of large Compustat

firms, a result that is consistent with Houston and James’s (1996) estimate that only 17%

of outstanding debt is public. Second, private debt, which includes syndicated loans, is

both easier to renegotiate and easier to liquidate than public debt (Edwards 1986,

Eichengreen and Mody 2000, Dichev and Skinner 2002, Allen and Gottesman 2005,

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Altunbas et al. 2006).1 As a result, private debt is more likely to include covenants

designed to address a variety of agency problems (Smith and Warner 1979, Gilson and

Warner 1998, DeAngelo et al. 2002).

Family firms have an ownership structure that lends itself well to the examination of the

agency costs arising from the debtholder-shareholder conflict and whether and how they

affect the decision to include covenants in debt contracts. In particular, family firm

ownership tends to be highly concentrated and family members tend to be relatively

poorly diversified. According to Anderson and Reeb (2003a), family members have over

69% of their wealth, on average, invested in their firms, and 45.7% of family firms have

founder or descendent CEOs. In addition, unaffiliated blockholders, who could serve as

strong external monitors, tend to hold significantly smaller percentages of shares in

family firms (Anderson and Reeb 2003b). Although the structure of family firms might

mitigate certain agency problems (in particular, the owner-manager agency problem),

Jensen and Meckling (1976) and Smith and Warner (1979) argue that when

management’s and shareholders’ interests are closely aligned, as they are in family firms,

the conflict of interest between shareholders and debtholders gives rise to opportunistic

behavior by managers in which debtholder wealth is expropriated. One method of

mitigating this agency cost is through the use of covenants that protect lender(s) from the

borrower using cash or assets in ways that increase the lender(s)’ risk. For example,

liquidity and net worth covenants specify minimum limits on financial measures such as

the current ratio, EBITDA, interest coverage, and the firm’s (tangible) net worth and thus

inhibit the transfer of cash and assets to shareholders. They also help to ensure that the

current debt can be serviced, and if not, that there are assets available for the lender(s) to

claim. Leverage covenants that restrict additional borrowing reduce the possibility of

opportunistic borrowing by managers and thus help to maintain the value of existing debt

by placing maximum limits on the debt already in place.

1 As Altunbas et al. (2006) observe, “[c]ompared to a larger number of non-coordinated investors in the case of bonds, syndicated loans have a small number of relatively well organized lenders acting uniformly against any repayment problems.” (p. 690)

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We hypothesize that family firms are more likely than non-family firms to include such

financial covenants in their private debt contracts. We further hypothesize that their

inclusion is even more likely if the family’s control over operations is increased through

the use of dual-class shares and/or if a family member is CEO.2 We also note that

because renegotiation of private debt contracts is relatively inexpensive (Dichev and

Skinner 2002, Allen and Gottesman 2005), even family members who have no history or

intention of expropriating debtholder wealth (consistent with their building or

maintaining reputation, Anderson et al. 2003) are more likely, relative to managers in

non-family firms, to find it beneficial, in net, to “tie their hands” through the use of

covenants and alleviate any concern of the lenders.3

We test our hypotheses by studying the financial (liquidity, net worth and leverage)

covenants included in 2,687 private loan packages of S&P 500 firms identified as family

firms by Business Week in its November 10, 2003, issue. Business Week defines a family

firm as: “…any company [in the S&P 500] where founders or descendants continue to

hold positions in top management, on the board, or are among the company’s largest

stockholders.” To identify these firms, Business Week relies on the methodology

developed by Anderson and Reeb (2003a) but fine-tunes the process by examining

individual firms in more detail, as required, to ensure that family members do in fact

exert significant influence on company operations. The private loan packages of the

other (non-family) S&P 500 firms serve as a control sample. We gather covenant and

loan package details, including average interest rate spread over LIBOR and maturity,

from the 2005 Dealscan database. We gather dual-class share information from the

Investor Responsibility Research Center database, CEO data from proxy statements and

2 As discussed in the next section, firms with a dual-class share structure (aka a two-tiered stock system) have one class of common stock with “superior” voting rights (more than one vote per share) and another class with “inferior” voting rights (one vote per share). In the case of family firms with dual-class shares, family members generally hold the super-voting shares and thus have significantly greater control over operations when compared to other shareholders. 3 Dichev and Skinner (2002) conclude that private debt covenants provide lenders with an option to step in and take action when conditions warrant, and that violations do not necessarily indicate severe financial problems. However, they also note that including covenants in debt agreements is not costless. Doing so requires management time, frequent reporting to and monitoring by lenders, and renegotiation and the possibility of additional covenants in the event of violation (Dichev and Skinner 2002, Beneish and Press 1993).

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other necessary data from Compustat. Because our sample is restricted to S&P 500

firms, we note for the reader that the slice of the private debt market we focus on is

accessed by some of the largest and most stable firms in the U.S. economy. Further, the

private debt in our sample is relatively short-term in nature: the average (median)

maturity is approximately three (two) years.

Our multivariate tests control for factors other than family-firm status that prior research

indicates affect the inclusion of covenants in debt contracts: leverage, growth, firm size,

earnings variability, firm credit rating, macroeconomic conditions as proxied by LIBOR,

deal amount, maturity and status as a financial firm. In addition, we supplement our

basic probit analysis with two-stage conditional maximum likelihood estimation (2SML)

to control for endogeneity in the interest rate and the inclusion of covenants that adjust

for firm-specific risk. The results are consistent with our expectations: The private loan

packages of family firms are more likely than those of non-family firms to include at

least one financial covenant. We also show that covenant “intensity,” as proxied by the

number of financial covenants in a loan package, is significantly greater for family firms.

Also as expected, the presence of dual-class shares, while not pervasive in our sample,

further increases covenant intensity and the probability of observing at least one financial

covenant in a loan package. When specific categories of financial covenants (liquidity,

leverage and net worth) are considered, we find that family firm status significantly

increases the likelihood of observing liquidity and net worth covenants being included in

the private debt contracts of our sample firms. Further, the presence of dual-class shares

has a significant incremental impact on the probability of observing liquidity covenants.

These results suggest that covenants that restrict managers’ ability to divert cash or assets

to shareholders to the detriment of debtholders are viewed as more beneficial, in net, for

family firms than non-family firms, especially in the presence of a two-tiered stock

system that strengthens the family’s operational control. Interestingly, we do not observe

a similar effect for leverage covenants that restrict additional borrowing. However, it is

possible that because of the short-term nature of the debt instruments in our sample, the

incentive problem addressed by leverage covenants (i.e., the incentive to issue more debt

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that reduces the value of existing debt) may not be particularly severe for our sample

firms.

Overall, our analysis provides evidence that family firms are associated with greater use

of financial covenants in private debt contracts, particularly when those covenants are

designed to identify whether the family-firm managers are increasing the lender(s)’ risk

by diverting cash or assets to shareholders. It also provides an indication of the value of

accounting information in mitigating the agency costs that arise from the concentrated

family ownership and control inherent in the structure of family firms. In particular, the

availability of reliable measures of the firm’s performance as presented in its financial

statements appears to be very important in helping borrowers and lenders reduce these

agency costs and contract more efficiently. Further, the importance of financial

statements to family firms in contracting is consistent with the findings in Ali et al.

(2007) and Wang (2006) that the financial disclosures of family firms are of higher

quality and are less likely to be manipulated for opportunistic reasons.

The rest of the paper is organized as follows. In Section 2, we review the literature and

develop our hypotheses. In Section 3, we present the results of univariate and

multivariate tests. In Section 4, we offer concluding remarks.

2. Motivation and Hypotheses Development.

Bank loans are a significant source of financing for U.S. firms (Houston and James 1996,

Denis and Mihov 2003). However, meeting the demands of their largest customers often

requires banks to assume excessive risk or pushes them to regulatory limits (Allen and

Gottesman 2005).4 As a result, many borrowers and lenders turn to syndicated debt.

Loan syndication allows banks to serve their largest customers while spreading risk and

avoiding regulatory limits (Allen and Gottesman 2005). In syndication arrangements, the

4 According to Allen and Gottesman (2005), regulatory restrictions include the requirement for some U.S. banks that they not lend more than 25%, and sometimes 10%, of capital to an individual borrower and that they finance a significant portion of the loan with expensive sources of financing, reducing the profitability of the loan.

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lead bank (the arranger) and the borrower set the terms of the loan (referred to as a credit

facility or tranche), and then the lead bank finds other lenders (referred to as participants,

usually other banks, insurance companies and other financial institutions) to join the

syndicate.5 Dichev and Skinner (2002) report that by the late 1990s, most sizable

commercial loans in the Dealscan database were syndicated, a finding that they attribute

to the increased prominence of this type of lending. Because of the way they are

structured, private loans, whether they are syndicated or not, are much easier to

renegotiate than public debt and therefore include more covenants (Edwards 1986,

Eichengreen and Mody 2000, Dichev and Skinner 2002, Allen and Gottesman 2005,

Altunbas et al. 2006).6

Family firms have a unique ownership structure in that founders or their descendants hold

senior management positions, sit on the board of directors, or are among the firm’s

largest shareholders (Anderson and Reeb 2003a). The family firm structure is common

throughout the world: LaPorta et al. (1999) report that approximately 30% of large

publicly traded firms worldwide are family firms. Anderson and Reeb (2003a) indicate

that within the U.S., the structure is also common: Approximately one-third of the S&P

500 consists of family firms. Not only does ownership tend to be concentrated in such

firms; family members also tend to be poorly diversified, with over 69% of their wealth,

on average, invested in the firm (Anderson and Reeb 2003a). Further, unaffiliated

blockholders (independent entities holding five percent or more of the firm’s shares), that

could serve as strong external monitors, have significantly smaller holdings in family

firms when compared to non-family firms (Anderson and Reeb 2003a). Although some

of the agency problems that arise in corporations might be mitigated by the structure of

family firms—in particular, the owner-manager (Type I) agency conflict, others could be

exacerbated. In particular, when dealing with firms where ownership is concentrated in

the family’s hands and/or family members hold influential positions, lenders are likely to

be particularly concerned about the debtholder-shareholder conflict of interest (Smith and 5 Private loan syndicate sizes range from 1 to 33, with an average of four lenders in a syndicate (Bradley and Roberts 2004). 6 Begley and Freedman (2004) provide evidence of a significant decline in the use of accounting-based covenants in public debt over the last fifteen years, a finding that is consistent with the difficulty of renegotiation when there are potentially thousands of bondholders.

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Warner 1979). In such firms, there is a greater likelihood that management will act in

ways that benefit shareholders at the lender’s expense by, for example, expropriating

lenders’ wealth either by altering the firm’s investment decisions or by disgorging assets

to shareholders (Tirole 2006, Grinblatt and Titman 2002).7

Business Week’s descriptions of family connections (i.e., ownership stake, senior

positions, and influence) in S&P 500 family firms, as they define them, indicate that

family members’ influence is indeed significant (see the Appendix for examples). As a

result, we expect the debtholder-shareholder conflict described by Smith and Warner

(1979) to be relatively severe in these firms. We also expect its severity to increase if the

family’s influence is increased through the presence of a family-member CEO and/or

dual class stock, in which family members hold supervoting shares that give them

significantly more control over important corporate decisions.8 Including covenants in

debt contracts is one method of protecting debtholders from the increased risk that

managers will use cash in ways that lower the value of debt (i.e., increase risk), and thus

we hypothesize that they are more likely to be included in the private debt contracts of

family firms than non-family firms, particularly if the firm has dual class shares and/or a

family member is CEO. Further, even if family members have no intention or history of

taking such actions (consistent with, for example, their building or maintaining

reputation, as argued in Anderson et al. 2003), they still might be relatively more likely to

find it beneficial, in net, to “tie their hands” through the use of covenants because of the

lender(s)’s concern. As noted in the introduction, this trade-off is particularly salient in

private debt contracts where renegotiation is relatively inexpensive. For example, Dichev

and Skinner (2002) report violations of approximately one-third of the net worth and

current ratio covenants in their sample of bank loans. This suggests to them that these

7 More specifically, lenders must be cautious about manager/family members’ investment strategies creating a debt overhang, asset substitution, short-sighted investment or a reluctance-to-liquidate problem (Grinblatt and Titman 2002, p. 563). They must also be cautious about stockholders diverting cash or assets toward share repurchases, dividend payments or extensive capital expenditures in illiquid assets—or liquidating working capital to cover short-term losses. 8 A recent example of such a two-tiered stock structure is Google’s initial public offering that included Class B shares that have 10 times the voting power of Class A shares. This dual-class share structure gave one-third of the voting power to the firm’s two founders and its chief executive. See Fan and Wong (2002), Gompers et al. (2004), Hauser and Lauterbach (2004), Francis et al. (2005) and the references therein for more details regarding dual-class companies.

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covenants act as monitoring devices or “trip wires” that provide the lenders with an

option to step in and take action when conditions warrant. They also show that such

covenants are generally set relatively tightly and that violations do not necessarily

indicate severe financial difficulty, consistent with Chen and Wei’s (1993) and Smith’s

(1993) observation that when covenants are violated, lenders often choose to not call the

loan but instead opt for a less punitive alternative such as resetting the covenant.9 As a

result, covenants appear to be effective monitoring devices.

The restrictive covenants that firms and their lenders might choose protect, albeit in

different ways, against the borrowing firm’s managers using cash or assets in a way that

increases the lender’s risk, consistent with their reducing the agency cost expected to be

more severe in family firms. Liquidity covenants (that are based on, for example, the

current or quick ratio and interest coverage) ensure that the firm’s operations generate

“sufficient” cash to service the debt. Similarly, net worth covenants (that are based on

financial statement measures of net or tangible net worth) ensure that cash and/or assets

are not diverted to shareholders but instead are used to service the debt or be available to

(partially) repay the loan in the event of default. Because of the way these covenants are

designed, we expect that both types will be more frequently included in the private debt

of family firms relative to non-family firms. In addition, the arguments in Begley and

Feltham (1999) suggest that leverage covenants (that are based on measures of the level

of debt usually relative to some measure of earnings or assets/equity) might also be more

frequently included in the debt contracts of family firms. Specifically, if lenders perceive

family firms as being more likely to opportunistically increase the value of equity

through future borrowing that also reduces the value of existing debt, then covenants that

restrict future borrowing also lower agency costs and may be more attractive to family

firms. However, we note that this problem might not be as severe for private debt, which

tends to be short-term in nature (average maturity of approximately three years; see, for

example, Dichev and Skinner 2002). 9 We want to emphasize that we are not implying that renegotiation is costless. It involves the time and cost of dealing with lender review, discussing forecasts and strategy with the lender(s) (Skinner and Dichev 2002), and possibly the addition of new covenants (Beneish and Press 1993). This means that borrowers and lenders trade off costs with benefits when deciding whether to include particular covenants in their debt contracts.

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3. Sample and Data.

Our sample consists of the loan packages, gathered from the 2005 Dealscan database, of

the 177 S&P 500 firms identified as “family firms” by Business Week in their November

10, 2003, issue. Business Week defines a family firm as “… any company where

founders or descendants continue to hold positions in top management, on the board or

among the company’s largest stockholders.” Business Week bases its definition on

Anderson and Reeb’s (2003a) methodology and enlists the help of Spencer Stuart to

identify the family firms.10 The loan packages of the remaining S&P 500 firms as of

June, 2003, serve as the non-family-firm (control) sample. Our sample period spans

1985-2005. We use the 2003 Business Week family firm/non-family firm classification

throughout our sample period based on the notion that family-firm status is sticky (Ali et

al. 2007).11 However, because CEO change is likely over our sample period, we examine

proxy statements to determine whether a family member is CEO at the inception of each

loan package in our sample. In addition, we use the Investor Responsibility Research

Center database to determine whether the firm has a dual-class stock system in place at

the inception of each loan package. We note for the reader that because of the way we

identify family firms and the control sample, the slice of the private debt market that we

examine is not representative of the entire private debt market. More specifically, our

focus on S&P 500 firms means that we examine the private debt of the largest firms in

the U.S.

We identify loan facilities (tranches) and packages and gather interest rate spread over

LIBOR (All-in-Spread Drawn), and other loan-specific and covenant information from

the Dealscan database. All facilities in a loan package are covered by all of the covenants

in the loan package in which they are contained, and so our unit of analysis is the

10 See “Defining Family,” Business Week, November 10, 2003, pp. 111-114, for details. Business Week notes that it examined individual firms more closely, when necessary, in order to ensure that companies identified as “family firms” were in fact those whose operations were significantly influenced by family members. 11 Movement across classifications is generally from family-firm to non-family-firm status; thus, misclassifications from the use of the 2003 designation are likely to bias against our finding results that support our hypotheses.

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package, not the individual facility.12 We require that an observation have maturity and

interest rate spread information in Dealscan in order to be included in our sample. We

gather other required financial and firm-specific information not contained in the

Dealscan database from Compustat and Investor Responsibility Research Center (IRRC)

databases. Table 1 describes the way our final sample consisting of 2,687 loan packages,

spanning the period 1985-2005, was formed. One-hundred-and-forty (79%) of the family

firms and 275 (85%) of the non-family firms in the S&P 500 as of June, 2003, are

associated with loan packages in our final sample.

The types of covenants included in the loan packages for our sample as well as brief

descriptions and break-down by specific covenants are presented in Table 2. (We code a

covenant as existing if it is indicated as existing in the Dealscan database and not existing

otherwise.) Table 2 shows that in our sample, financial covenants (liquidity, leverage

level and net worth covenants) are frequent: 1,154 packages contain at least one financial

covenant. Liquidity covenants (minimum limits placed on the firm’s ability to service its

debt obligations, N=1,118) are the most common financial covenant in our sample,

followed by leverage level covenants (maximum limits placed on leverage, N=734), and

then net worth covenants (minimum limits placed on the level of the firm’s net worth,

N=327). Of the liquidity covenants, minimum interest coverage occurs most frequently

(N=1,125), followed by minimum debt service coverage (N=418).13 (These subtotals

indicate that loan packages in our sample often contain more than one liquidity

covenant.) Of the leverage level covenants, maximum leverage ratio occurs most

frequently (N=371), followed by maximum debt to EBITDA (N=302). Like Dichev and

Skinner (2002), we observe variations in the ratios used in leverage and liquidity

covenants, consistent with Leftwich’s (1983) argument that private loan agreements are

often tailored to borrower characteristics. These variations are not critical for our

purpose (examining the existence of covenants in family-firm versus non-family-firm

12 Consistent with prior research, we find that a large number of deals in Dealscan are “packages” or bundles of facilities (e.g., a one-year line of credit and a longer term note). On average, loan packages of S&P 500 firms contain 1.4 facilities. (The averages for S&P 500 family and non-family firms are also 1.4.) Dealscan data is organized so that each facility has a unique identifier of its own as well as a package identifier. 13 Some packages have multiple facilities with different interest coverage ratios.

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private loans), and so we focus on the broader categories of financial covenants

(liquidity, leverage and net worth) as opposed to specific covenants in the empirical

analysis that follows.

4. Empirical Results.

4. 1 Univariate Tests.

Table 3 presents univariate comparisons between family firms and non-family firms and

their loan packages. Table 4 contains Pearson and Spearman correlations among most of

the variables examined in Table 3. Panel A of Table 3 shows that family firms associated

with the loan packages in our sample are not significantly different from the non-family

control firms in terms of leverage (long-term debt scaled by total assets), consistent with

Anderson and Reeb (2003b), and growth (book-to-market). However, these same family

firms are significantly smaller in terms of total assets, on average, than the non-family

firms (p=0.000), and there is some evidence that their earnings are more volatile than

those of non-family firms (p=0.062). The percent of family-firm loan packages where

the borrower is a financial institution (SIC 6000-6799) is smaller than it is when the non-

family-firm loan packages are considered: 10.8% versus 13.7%. Further, family firms

associated with the loan packages in our sample have, on average, a slightly worse credit

rating than the non-family firms (3.743 versus 3.673 on a 1 to 7 scale where 1=AAA

credit rating and 7=below B credit rating—see the footnote to Table 3 for details),

although the median credit ratings are the same for both groups and the statistical

significance of the difference in means is marginal (p=0.083).14 They are also more

likely to have dual class stock systems (13.4%) than the non-family firms (4%), although

we note that such systems are not pervasive in our sample.

The purpose of the majority of facilities in our sample loan packages (approximately 60%

of the family firm facilities and 76% of the non-family firm facilities) is for “everyday

use” (e.g., general operations, short-term purchases, commercial paper backup). Less

14 We use firm credit rating, instead of issue-specific bond ratings, because it is a measure of the rating agency’s assessment of the firm’s inherent default risk rather than the default risk of a particular debt instrument, which can depend in part on the type and number of covenants attached.

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than 15% are for the purpose of debt consolidation or refinancing. Consistent with prior

research that examines private debt from Dealscan (e.g., Dichev and Skinner 2002),

average loan package maturity in our sample (based on the maturity of the longest-

maturity facility in the package) is approximately three years.15 In addition, we find no

statistical difference in mean maturities for family and non-family firm loan packages,

N=851 and 1,836, respectively. When we weight each facility’s maturity by its relative

proportion of the deal amount to arrive at a weighted average maturity for each package,

the means for both types of firms increase slightly (35.2 months versus 34.6 months), but

are still statistically indistinguishable from one another.16 Interestingly, the average deal

amount for family firms (7.45) is significantly smaller than the average deal amount for

non-family firms (11.4). In addition, the mean simple average spread (across facilities in

the package) in terms of basis points over LIBOR is higher for family firms (85.638 bps)

than for non-family firms (65.758 bps), which is consistent with the somewhat lower

average credit rating for family firms in our sample. Even though this difference in

spreads is statistically significant, we note that it is small in economic terms: the mean

(median) difference in average spreads across the two groups is only 0.2% (0.1%).

Further, when we weight the spread in each facility by its relative proportion of the deal

amount to arrive at a weighted average spread for each package, the means for family and

non-family firm packages change by very little (85.434 bps versus 65.279 bps).

Consistent with our expectations, the covenant frequency information in Panel B of Table

3 indicates that significantly larger percentages of family firm loan packages include

covenants than non-family firm loan packages. Specifically, 47.8% of family firm loan

packages contain at least one financial covenant, compared to 40.8% of non-family firm

loan packages. In addition, covenant “intensity,” as measured by the number of

covenants in a loan package, is also significantly greater for family firm loan packages:

1.257, on average, for family firm packages versus 0.941, on average, for non-family

firm packages. When specific types of covenants are considered, the same pattern 15 Approximately three-fourths of the family and non-family firm facilities are 364-day facilities or revolvers. 16 This weighting will provide some control for differences in maturity of the dominant facilities in each package. Although the means are not statistically different from one another with this weighting scheme, the medians significantly change, especially for the non-family firm packages.

14

continues to hold: 45.9% (39.6%) of family firm (non-family firm) loan packages

contain liquidity covenants; 30.1% (26.0%) contain leverage covenants; and 15.9%

(10.4%) contain net worth covenants. These univariate comparisons provide an initial

indication that family firms are more likely to include covenants of all kinds—and more

of them—in their private loan packages than are non-family firms, consistent with their

being useful in reducing the agency costs arising from the potentially more severe

debtholder-shareholder conflict in family firms. However, because factors other than

ownership structure affect the decision to include covenants, we next turn to multivariate

tests that control for other influencing factors.

4.2 Basic Models.

Panels A and B of Table 5 contain in the results of basic probit regressions designed to

predict the probability of at least one financial covenant being included in a single loan

package and the Poisson and OLS regressions designed to explain covenant intensity (the

number of covenants included in a single loan package), respectively.

More specifically, the full probit model in Panel A is: Prob (at least one financial covenant) = F (β0 + β 1 Family Firm Dummy i + β 2 Leverage i (1) + β 3 Growth i + β 4 Firm Size i + β 5 Earnings Variability i + β 6 Firm Credit Rating i + β 7 LIBOR i + β 8 Financial Firm Dummy i + β 9 Dual Class Dummy i + β 10 Deal Amount i + β 11 W.A. Maturity i + β12 W.A. Spread i + ζi )

The full Poisson and OLS models in Panel B are:

Covenant Intensity Indexi = α0 + α1 Family Firm Dummy i + α2 Leverage i + α3 Growth i (2) + α4 Firm Sizei + α5 Earnings Variability i + α6 Firm Credit Rating i + α 7 LIBOR i + α8 Financial Firm Dummy i + α9 Dual Class Dummy i + α10 Deal Amount i + α11 W.A. Maturity i + α12 W.A. Spread i + εi

We also estimate the models without the Dual Class Dummy to see whether our results

are sensitive to its inclusion. Analogous models that include an Outsider CEO Dummy

are presented in Panels A and B of Table 6.

15

The dependent covenant variable in the probit models is dichotomous; and the covenant

intensity index, as mentioned above, is a simple count of the number of financial

covenants included in the package. The explanatory variables of interest to us are the

Family Firm Dummy variable, which takes on the value of 1 if the borrower is a family

firm and 0 otherwise (included in both Tables 5 and 6); the Outsider CEO Dummy

variable, which takes on the value of 1 if the firm’s CEO is not a family member and 0

otherwise (included in Table 6 only, with the Family Firm Dummy variable); and the

Dual Class Dummy which takes on the value of 1 if the firm has a dual class stock system

(included in one version of each model in both Tables 5 and 6).

Control variables are those identified in prior research (e.g., Begley and Feltham 1999) as

being associated with the presence of covenants: (1) Leverage as measured by ratio of

long-term debt to total assets as of the beginning of the quarter in which the loan is

initiated; (2) Growth as measured by the book-to-market ratio; (3) Firm Size as measured

by the log of total assets; (4) Earnings Variability as measured by the standard deviation

of the ratio of annual operating income to total assets using data from the prior three

years; (5) Firm Credit Rating as measured by the S&P long-term domestic issuer credit

rating and coded as 1, 2, … , 7 where 1 = AAA rating which is the highest rating and 7=

below B which is the lowest rating; (6) LIBOR as measured by the 12-month U.S. dollar

denominated LIBOR rate as of June 30 of the current year; (7) Financial Firm Dummy

which takes on the value of 1 if the firm is a financial institution (SIC 6000-6799) and 0

otherwise; (8) Deal Amount as measured by the size of the loan deal; (9) W.A. (Weighted

Average) Maturity as measured by the sum of the maturities of each facility in the

package weighted by that facility’s proportion of the total deal amount; and (10) W.A.

(Weighted Average) Spread as measured the sum of the amounts the borrower pays in

basis points over LIBOR for each faculty in the package weighted by that facility’s

proportion of the total deal amount.17

17 Recall that a firm’s credit rating is a measure of the rating agency’s assessment of the firm’s inherent default risk. The advantage of using this rating versus a bond rating is that the latter is affected by the covenants attached to the debt contract (Weber 2006).

16

We expect Leverage, Earnings Variability, Firm Credit Rating, Deal Amount and W.A.

Maturity to be positively associated with the inclusion of covenants since they indicate

higher risk for lenders. We expect Firm Size, Growth and LIBOR to be negatively

related to the inclusion of covenants because larger firms (in terms of total assets) and

non-growth firms (as reflected in high book-to-market ratios) are likely to be less risky

from the lender’s perspective, and because LIBOR tends to rise (fall) with better (worse)

economic conditions and thus provides a control for the effect of general economic

conditions on the probability of including covenants. (We expect a negative sign on the

coefficient for LIBOR because worse economic conditions can be reasonably expected to

increase the probability of a covenant, Bradley and Roberts 2004.) We include a

financial firm dummy as a control variable because financial firms have a different

capital structure than non-financial firms and are often subject to additional regulation.

As a result, their propensity to include covenants may be different from that of non-

financial firms. We also expect the weighted average interest rate spread over LIBOR

(W.A. Spread) to be related to the inclusion of covenants, but we are unable to predict the

sign of the relation. It could be the case that there is a trade-off between spread and the

presence of covenants as alternative means of protecting against risk, creating a negative

relation; but it could also be the case that even in the presence of such a trade-off, loans

with higher spreads are also more likely to include covenants because of higher perceived

risk, creating a positive relation between the two.18

The results of the basic probit regressions in Panel A of Table 5 indicate that family firm

status significantly increases the probability of at least one financial covenant being

included in private debt, consistent with our expectations, and that the presence of dual

class shares further increases the probability. (Coefficients for both variables are positive

and significant at p<0.01.) The conclusion drawn from these initial results—that family

firms are more likely than non-family firms to include financial covenants in their private

debt contracts—is further supported by the evidence in Panel B of Table 5. In both the

18 That is, since higher spreads and covenants are used together to reduce the lender’s risk, using them in combination should result in riskier borrowers’ loans having higher spreads and more covenants. The results for the family firm variables are not sensitive to our using a simple average versus weighted average spread variable.

17

Poisson and OLS regressions, family firm status is positively and significantly associated

with the covenant intensity index, a result that indicates that family firms tend to have

greater numbers of financial covenants in their private debt packages than non-family

firms. And, once again, the presence of dual class shares has significant incremental

explanatory power beyond that of the family firm variable. This suggests that when

family control is strengthened through the unusual voting rights afforded by dual class

shares, additional covenants are generally placed on the firm’s private debt.

In Panel C of Table 5, we consider the effect of family firm and dual class share status on

the inclusion of specific types of financial covenants (liquidity, leverage and net worth).

The results of the basic probit estimations show that family firm status increases the

probability of liquidity and net worth covenants being included in private debt, consistent

with our expectations. However, it does not appear to be significant in determining the

probability of leverage covenants. Further, the presence of dual class shares increases the

likelihood of liquidity covenants but is not incrementally significant in explaining the

probability of leverage or net worth covenants. These findings, when considered

together, indicate that after controlling for other influencing factors, family firms are

more likely to include covenants that monitor inflows or outflows of cash not associated

with additional borrowing in their private debt contracts than are non-family firms, and

that dual class stock structures are important determinants of the inclusion of liquidity

covenants in particular. One possible explanation for the lack of family-firm influence on

the inclusion of leverage covenants is that the private debt contracts we examine are

relatively short-term in nature, making the ability to service the debt more important than

the restriction of additional borrowing. (Not only is the average maturity of the facilities

in our sample short; as noted earlier, a significant percent of the facilities in the packages

in our sample are short-term.)

As explained in the previous section, the agency problem that financial covenants address

might well be mitigated if the chief executive officer is not a family member. Table 6

reports the results of the same models presented in Table 5 except that both a Family

Firm Dummy and an Outsider CEO Dummy are included as explanatory variables. (We

18

also continue to include a Dual Class Dummy variable in one version of each model.)

The coefficient for the Family Firm Dummy variable continues to be significantly

positive—and of roughly the same magnitude—in the basic probit regressions (for the

inclusion of at least one financial covenant) in Panel A and in the Poisson and OLS

regressions (to explain covenant intensity) in Panel B. The Dual Class Dummy also

continues to be positive and significant in all of the regressions in which it is included.

However, the Outsider CEO Dummy is not statistically significant in any of the

regressions in Panels A and B. When we consider individual types of covenants (Panel

C), the Family Firm and Dual Class Dummy variables continue to be positive and

significant for liquidity covenants, and they continue to have no significant impact on the

inclusion of leverage covenants. Consistent with what we find in Panels A and B, the

Outsider CEO Dummy variable is not significant in either the liquidity or leverage

covenant model. However, we observe some changes in the net worth covenant

regressions: The Outsider CEO Dummy has a significant, negative impact on the

inclusion of net worth covenants (consistent with non-family control in the CEO position

mitigating the agency costs that might also be reduced by including a net worth

covenant), and the Dual Class Dummy variable is marginally significant and negative.

Even so, the results in Table 6, taken together, do not provide strong support for an

outsider CEO having a significant impact on the inclusion of financial covenants in

private debt contracts. One possible explanation for this is that Business Week’s family

firm classification scheme is designed to ensure significant family influence, regardless

of its source, making it difficult to pick up an incremental effect for an outsider CEO in

the regressions. Alternatively, significant family firm influence may simply mitigate the

potential benefits of an outsider CEO.

As expected, several of the control variables (Firm Size, Firm Credit Rating, LIBOR,

Deal Amount) are significant and of the predicted sign regardless of the covenant

measure considered and the regression that is estimated. In addition, the coefficient for

W.A. Spread is generally positive and significant, suggesting that loan packages with

higher spreads are more likely to include all types of financial covenants. The Growth

and Earnings Variability control variables, however, are statistically insignificant in each

19

of the regressions, consistent with the weakness of the results of the univariate tests in

Table 3. Leverage is significant and of the expected sign in all regressions except the net

worth probit regressions. W.A. Maturity is either insignificant, or in the case of liquidity

covenants and the probit regressions for the inclusion of at least one financial covenant,

significant and negative. Again, these results could be due to the short-term nature of the

loan packages that we examine. To summarize: Although there is some variability in the

significance of the control variables, the basic models in Tables 5 and 6 provide strong

evidence that family firms are more likely than non-family firms to include financial

covenants, especially liquidity and net worth covenants, in their private debt agreements,

and that the presence of a two-tiered stock system increases the likelihood their inclusion.

The models also indicate that family firms have more financial covenants, on average,

per loan package than do non-family firms.

4.3. 2SCML Estimation.

As is true for other studies that examine the likelihood of covenants being included in

debt contracts, we face an endogeneity problem. In particular, it is likely that the

inclusion of covenants and the interest rate spread are jointly determined in the

negotiations between borrower and lender. Before proceding, we note for the reader, as

did Begley and Feltham (1999), that many of the other explanatory variables that are

treated as exogenous in studies such as ours are also the outcomes of firm decisions. We

focus on interest rate spread as the endogenous explanatory variable in our probit

estimations because it is the one for which the endogeneity problem is likely to be most

severe in the context of a loan package. As a result, we check the robustness of our basic

results by using two-stage conditional maximum likelihood estimation (2SCML). In a

system of two equations where one equation has a dichotomous variable and the other has

a continuous variable on the left-hand side (as will be the case for us), Rivers and Vuong

(1988) show that 2SCML produces consistent estimates.

In our 2SCML estimation, the first stage for each type of covenant involves estimating a

reduced form regression with weighted average spread as the dependent variable and all

20

explanatory variables from the basic probit regressions in Tables 5 and 6 except the

(endogenous) W.A. Spread variable, plus a dummy variable for whether the debt is

secured and another for the existence of other covenants as independent variables. This

structure assumes that the interest rate charged for the debt is likely to be affected by

whether the debt is secured (Asquith et al. 2005, Beatty et al. 2002 and the references

therein) and by the use of other covenants. In the second stage, we include the residuals

from the first-stage regression as well as the (endogenous) W.A. Spread variable in a

probit model for the covenant measure we are currently examining. An advantage of this

procedure is that it allows for the testing of endogeneity through comparison of the log of

the likelihood functions calculated with and without the residuals in the second stage

(Alvarez and Glasgow 2000, Timpone 2003).

We present the second-stage probit estimation results in Tables 7 and 8. Table 7 contains

the estimation results with the Family Firm Dummy variable only, and Table 8 contains

the estimation results with both the Family Firm and Outsider CEO Dummy variables.

The results are largely consistent with the results from the basic models. In particular,

family firm status continues to be associated with an increase in the probability of at least

one financial covenant being included in a private loan package, as does the presence of

dual class stock. The presence of an outsider CEO does not change the probability. The

results for specific types of covenants are also generally consistent with the prior results

with the following exceptions. The Family Firm Dummy variable loses significance (p=

0.139) in the liquidity covenant probit in Table 8 (however, the Dual Class Dummy

retains its significance and positive sign); and the Outsider CEO Dummy variable

becomes significant and has a negative sign in the net worth covenant regressions in

Table 8. Likelihood ratio tests indicate significant endogeneity in all of the probits, and

consistent with this, the spread residual is significant in each regression in Tables 7 and 8.

This also indicates bias in the coefficients estimated in the basic probit regressions in

Tables 5 and 6 (Rivers and Vuong 1988, Greene 2000). Consistent with this, a

comparison of the coefficients in Table 7 (8) with those in Table 5 (6) reveals some

differences. Firm size and deal amount continue to be consistently significant and of the

predicted sign for all the types of covenants in Table 7. However, the leverage variable

21

loses significance in all probits but the net worth probit. Growth and Firm Credit Rating

lose significance in the liquidity probit, and LIBOR loses significance in the net worth

covenant probit. W.A. Spread gains significance in the probit for determining the

probability of at least one financial covenant. Similar changes occur when Tables 6 and 8

are compared. However, overall, the basic results regarding family-firm status and the

presence of dual class shares generally hold.19

Overall, our analysis of the private loan packages of S&P 500 firms indicates that family

firms are more likely to include certain financial covenants in their private debt contracts

than are non-family firms, consistent with their usefulness in reducing agency costs

arising from the potentially more severe debtholder-shareholder conflict in family firms.

This highlights the importance of both income-statement and balance-sheet (flow and

stock) measures in reducing agency problems in the private debt market. In particular,

the accounting-based covenants employed more often by family firms are designed not

only to prevent diversion of cash from operations and outside sources to shareholders;

they also ensure that the debt can be serviced—and if not, that there are assets available

for the lender(s) to claim. If family influence is heightened due to operational control by

the presence of dual class stock, covenants appear more frequently, suggesting that in

such circumstances, accounting measures become even more important in reducing the

lender(s)’s risk.

5. Conclusions.

Family firms (public companies in which the founding family continues to hold top

management and/or board positions or a large ownership position) are a common

19 We focus on the 2SCML approach to our endogeneity problem because, in principle, it allows us to adjust for endogeneity arising from the decisions by both the borrower and the lender(s) as they negotiate the terms of the private debt placement. However, as an additional sensitivity check, we also use a self-selection model (Heckman 1979) to predict the inclusion of specific covenant types. Heckman’s self-selection methodology focuses on endogeneity arising from the decisions of just one party—in our context, the borrower, which would be appropriate if the lending side of the market is perfectly competitive. Results (not tabulated) again show that there is an endogeneity problem that needs to be corrected (the inverse Mills ratio is significant in the interest rate spread regressions). The Heckman results are generally qualitatively similar to the 2SMCL results. We thank Doug Schroeder for extensive discussions concerning the use of both methodologies.

22

organizational form. While more prevalent in Europe and Asia, family firms are

common in the U.S. Approximately one-third of the firms making up the S&P 500 are

classified by Business Week and Anderson and Reeb (2003a) as family firms. The unique

structure of family firms results in an unusually close alignment of manager and

shareholder interests, increasing the possibility of opportunistic behavior by managers in

which debtholder wealth is expropriated (Jensen and Meckling 1976, Smith and Warner

1979). In this paper, we ask whether this more severe agency problem results in family

firms more often including restrictive covenants in their private debt contracts than non-

family firms. We focus on private debt because it dominates the market for corporate

debt and is relatively inexpensive to renegotiate, making the inclusion of covenants more

likely.

We test our hypotheses on 2,687 private debt contracts of family firms and non-family

firms in the S&P 500 as identified by Business Week in their November 10, 2003, issue,

using covenant and other contract-specific data (such as interest rate spread over LIBOR

and maturity) gathered from the 2005 Dealscan database. After controlling for other

factors that are likely to influence the inclusion of financial covenants in debt contracts,

we find that family firms make more frequent use of covenants that restrict the firm’s

ability to divert cash and /or assets to shareholders at the expense of debtholders (i.e.,

liquidity and net worth covenants), when compared to non-family firms. However, they

are no more likely than non-family firms to include leverage covenants that restrict

additional borrowing. This suggests that in the private debt market, where contracts are

generally short-term in nature (average maturity of approximately three years), debt

service is a more important issue for family firms than is additional, opportunistic

borrowing that could affect the value of existing debt. When the firm employs a two-

tiered stock system that includes supervoting shares, all types of financial covenants are

more likely to be included in private debt deals. Our basic results hold across both basic

probit and two-stage conditional maximum likelihood estimation.

Overall, our findings indicate that covenants that prevent substantial diversion of cash to

shareholders, regardless of how it is generated, are perceived as more beneficial, in net, to

23

family firms when they enter the private debt market. It also suggests that accounting

numbers from both the income statement and balance sheet play a central role in the

private debt contracts of family firms and that they are useful in mitigating the agency

costs that arise from the concentrated ownership and significant operational influence of

family members. As such, our findings complement those in Ali et al. (2007) and Wang

(2006), who document superior earnings quality (and less earnings management) for

family firms.

24

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Appendix: Selected family firms and descriptions of family involvement from “Family, Inc.,” Business Week, November 10, 2003

Anheuser-Busch: August A. Busch III, the brewer’s chairman, owns 7.7 million shares. One son is his executive assistant; another runs domestic brewing operations. Wm Wrigley Jr. Company: President and CEO William Wrigley Jr. is the great-grandson of the man who started the confections company. He owns 21% of the common stock. Carnival: Heirs to the cruiseline’s founder include CEO Micky Arison. They own shares representing 32% of the voting power. Leggett & Platt: Chairman emeritus Harry M. Cornell Jr. is the grandson of the furniture-parts company’s co-founder. Cornell’s son-in-law, Lance B. Beshore, is a v-p. Illinois Tool Works: Harold B. Smith, grandson of the founder, is a retired officer but remains a director. The Smith family owns 12% of the industrial comglomerate. Cintas: Richard T. Farmer branched out into uniform rentals from his family’s rag reclamation company. He is chairman, and Scott D. Farmer, his son, is CEO. Boston Scientific: Co-founders of the medical-devices company, Peter M. Nicholas and John E. Abele, are chairman and director, respectively. Combined family ownership: 20.2%. Oracle: Co-founder Lawrence J. Ellison is chairman and CEO, and owns a fourth of the database-software supplier. Medimmune: Founder Wayne T. Hockmeyer is chairman of the company, whose drugs help prevent infectious diseases. John, his son, is a product manager in marketing. Yahoo!: The internet portal’s founders are active: Jerry Yang is a director and strategist; David Filo builds the technology. They own a combined 14.6% of the shares. Costco Wholesale: Founders James D. Sinegal and Jeffrey H. Brotman are CEO and chairman of the membership warehouse chain. Michael, Sinegal’s son, is a v-p in Japan.

29

Table 1: Details of Sample Formation Number of private loan packages for S&P 500 firms from the 2005 Dealscan database

4,000

Observations eliminated due to: Missing spread data on Dealscan 842 Missing maturity data on Dealscan 166 Unavailability of credit rating data (Compustat) 88 Unavailability of data for earnings variability calculation (Compustat) 170 Unavailability of data for growth calculation (Compustat) 30 Unavailability of data for leverage calculation (Compustat) 17 Final sample of private loan packages 2,687

30

31

Table 2: Financial Covenant Details for Sample of Private Loans Packages of S&P 500 Family and Non-family Firms, from the 2005 Dealscan Database, (N=2,687) Covenant Type Specific Covenant Frequency Liquidity Covenants: Min cash interest coverage 11 Minimum limits placed on debt Min current ratio 9 coverage. Min debt service coverage 418 Min EBITDA 25 Min interest coverage 1,125 Min quick ratio 11 Min fixed charge coverage 117 Total # of packages with liquidity covenants 1,118 Leverage Level Covenants: Max debt to EBITDA (Cash Flow) 302 Maximum limits placed on the Max debt to equity 9 leverage ratio. Max debt to tangible net worth 62 Max leverage ratio 371 Max senior debt to EBITDA (Cash Flow) 11 Max senior leverage 1 Total # of packages with leverage covenants 734 Net Worth Covenants: Net worth covenant 210 Minimum limits placed on the Tangible net worth covenant 117 level of a firm’s net worth. Total # of packages with net worth covenants 327

The sample consists of private loan packages, with interest rate spread and maturity information available in the 2005 Dealscan database, made to the family and non-family firms in the S&P 500 as identified in Business Week, November 10, 2003 (N=2,687). Covenants are “…specific financial restrictions which dictate how a borrower must carry themselves financially in order to avoid breaching the loan agreement.” (Dealscan, 2005) Definitions of specific covenants provided by Dealscan, 2005: Fixed Charge Coverage: EBITDA divided by (Interest Charges paid plus long-term Lease Payments); Debt Service Coverage: EBITDA divided by (Interest Expense plus the quantity of Principal Repayments); Interest Coverage: Earnings (e.g., EBIT, EBITDA, Net Income) divided by Interest Expense; Cash Interest Coverage: Operating Cash Flow divided by Cash Interest Expense; Leverage Ratio (Debt to Equity): Debt divided by Capitalization (or Equity); Debt To Cash Flow: Outstanding Debt divided by (Net Income plus Depreciation and Other Non-Cash Charges); Sr. Debt to Cash Flow: Outstanding debt on a Senior Basis divided by (Net Income plus Depreciation and other Non-cash Charges); Debt To Tangible Net Worth: Total Debt divided by (Net Worth minus Intangible Assets); Current Ratio: Current Assets (cash, marketable securities, accounts receivable, inventories, etc.) divided by Current Liabilities (accounts payable, short-term debt of less than one year, etc.); Tangible Net Worth: (Total Assets less Intangible Assets) minus Total Liabilities; and Net Worth: Assets minus Liabilities.

32

Table 3: Univariate Comparisons Between Family-Firm and Non-Family-Firm Private Loan Packages from Dealscan Panel A: Comparison of Firm and Package Characteristics: Family Firm Loan Packages

N =851 Non-Family Firm Loan Packages

N = 1,836 Test of Difference in

Means/Percents Mean Median Std. Dev. Mean Median Std. Dev. t/Z-statistic p-value

Firm Characteristics at Loan Inception: Leverage, scaled by Total Assets 0.248 0.217 0.177 0.240 0.232 0.146 1.28 0.201 Growth (Book to Market) 0.417 0.338 0.380 0.440 0.400 0.392 -1.41 0.159 Firm Size (ln Total Assets) 3.712 3.700 0.538 4.005 4.040 0.601 -12.15 0.000 Earnings Variability 0.025 0.014 0.045 0.022 0.014 0.034 1.86 0.062 Firm Credit Rating 3.743 4.000 0.891 3.673 4.000 1.000 1.73 0.083 Percent Financial Firms 10.8% --- --- 13.7% --- --- -2.19 0.029 Percent with Dual Class Stock 13.4% --- --- 4.0% --- --- 8.98 0.000

Package Characteristics: Deal Amount 7.45 4.10 10.45 11.4 6.00 17.18 -6.20 0.000 Maturity (months) 34.823 30.000 25.099 34.072 18.000 29.216 0.65 0.518 Weighted Average Maturity (months) 35.214 36.000 24.361 34.599 31.200 28.361 0.55 0.585 Average Spread (bps) 85.638 50.000 87.796 65.758 40.000 76.107 5.99 0.000 Weighted Average Spread (bps) 85.434 50.000 87.667 65.279 40.000 75.831 6.09 0.000 Covenant Intensity Index (# covenants) 1.257 0.000 1.525 0.941 0.000 1.307 5.51 0.000

Panel B: Comparison of Types of Covenants Included in Loan Package

Family Firm Loan Packages N =851

Non-Family Firm Loan Packages N = 1,836

Test of Difference in Percents

Financial Covenant Type: Percent Containing Covenant(s) Percent Containing Covenant(s) Z-statistic p-value At Least One Financial Covenant 47.8% 40.8% 3.43 0.001 Liquidity Covenants 45.9% 39.6% 3.09 0.002 Leverage Covenants 30.1% 26.0% 2.19 0.029 Net Worth Covenants 15.9% 10.4% 3.79 0.000 Footnote on following page.

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Footnote for Table 3: The sample consists of private loan packages, with interest rate spread and maturity information available in the 2005 Dealscan database, made to the family and non-family firms in the S&P 500 as identified in Business Week, November 10, 2003 (N=2,687). Variable definitions are as follows. Leverage: ratio of long-term debt to total assets (Compustat item # 51 / item # 44); Growth: book-to-market ratio (Compustat item # 59 /(item # 14 X item # 61); Firm Size: log of total assets (log of Compustat item # 44); Earnings Variability: the standard deviation of the ratio of annual operating income to total assets, computed using up to three years of historical data as available (Compustat item # 18 / item # 6); Credit Rating: S &P long-term domestic issuer credit rating from Compustat, coded 1 through 7 as follows: AAA=1; AA=2; A=3; BBB=4; BB=5; B=6; below B=7; Percent Financial Firms: the percent of packages for financial institutions as identified by membership in SIC 6000-6799; Percent with Dual Class Stock: the percent of package for firms with classes of common stock with equal rights to cash flows but with unequal voting rights; Deal Amount: deal size in US$; Maturity: stated maturity in months; Weighted Average Maturity: the sum of the maturities of each facility in the package weighted by that facility’s proportion of the total deal amount; Average Spread: the average amount the borrower pays in basis points over LIBOR, inclusive of all fees for a deal; Weighted Average Spread: the sum of the amounts the borrower pays in basis points over LIBOR, inclusive of all fees for a deal, for each faculty in the package weighted by that facility’s proportion of the total deal amount; Covenant Intensity Index: the number of financial covenants in the package. Covenants are described in Table 2.

34

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 161. Family Firm Dummy 0.025 -0.03 -0.23 0.036 0.033 0.066 -0.04 0.171 -0.12 0.011 0.117 0.066 0.060 0.042 0.077 0.201 0.157 <0.01 0.062 0.083 <0.01 0.040 <0.01 <0.01 0.585 <0.01 <0.01 <0.01 0.029 <0.012. Leverage -0.01 -0.06 0.024 -0.04 0.199 -0.02 -0.07 0.083 0.053 0.093 0.336 0.105 0.103 0.092 0.017 0.506 0.004

0.216 0.042 <0.01 0.282 <0.01 <0.01 <0.01 <0.01 <0.01 <0.01 <0.01 <0.01 0.382

3. Growth -0.08 0.077 0.176 -0.04 0.176 -0.09 0.128 -0.06 -0.04 -0.05 0.182 0.019 0.024 0.027 0.035 <0.01 <0.01 <0.01 0.024 <0.01 <0.01 <0.01 <0.01 0.067 0.006 <0.01 0.316 0.208 0.160 0.0714. Firm Size -0.23 0.089 0.228 -0.12 -0.20 -0.28 0.282 -0.04 0.425 -0.20 -0.11 0.008 0.02 -0.07 -0.03 <0.01 <0.01 <0.01 <0.01

<0.01 <0.01 <0.01 0.023 <0.01 <0.01 <0.01 0.675 0.334 <0.01 0.122

5. Earnings Variability 0.036 0.019 -0.12 -0.21 0.103 0.008 -0.135 0.022 0.003 -0.01 0.153 0.050 0.045 0.055 -0.002 0.060 0.328 <0.01 <0.01 <0.01

0.663 <0.01 0.260 0.886 0.634 <0.01 0.009 0.020 <0.01 0.908

6. Firm Credit Rating 0.056 0.225 0.214 -0.16 0.171 0.059 -0.156 -0.02 -0.129 0.098 0.406 0.101 0.098 0.165 0.097 <0.01 <0.01 <0.01 <0.01 <0.01 <0.01

<0.01 0.361 <0.01 <0.01 <0.01 <0.01 <0.01 <0.01 <0.01

7. LIBOR 0.062 -0.04 -0.07 -0.25 0.020 0.055 -0.02 0.014 -0.02 0.226 -0.12 -0.26 -0.28 -0.169 -0.02 <0.01 0.035 <0.01 <0.01 0.291 <0.01 0.239 0.469 0.358 <0.01 <0.01 <0.01 <0.01 <0.01 0.2828. Financial Firm Dummy -0.04 -0.120 0.209 0.241 -0.29 -0.17 -0.02 0.013 -0.02 -0.06 -0.03 -0.02 -0.02 -0.06 0.137 0.039 <0.01 <0.01 <0.01 <0.01 <0.01 0.380 0.497

0.335 0.001 0.093 0.218 0.366 <0.01 <0.01

9. Dual Class Dummy 0.171 0.036 -0.12 -0.06 0.002 -0.03 0.015 0.013 0.007 0.004 0.005 0.074 0.073 0.035 -0.02 <0.01 0.060 <0.01 <0.01 0.923 0.088 0.451 0.497 0.721 0.839 0.776 <0.01 <0.01 0.071 0.25910. Deal Amount -0.15 0.138 -0.05 0.565 -0.00 -0.137 -0.07 -0.02 -0.03 -0.03 -0.10 0.071 0.064 0.010 -0.02 <0.01 <0.01 0.010 <0.01 0.877 <0.01 <0.01 0.329 0.110 0.179

<0.01 <0.01 <0.01 0.619 0.320

11. W.A. Maturity 0.028 0.061 -0.03 -0.23 -0.01 0.110 0.212 -0.06 0.003 0.016 0.018 -0.06 -0.07 -0.01 -0.01 0.140 <0.01 0.108 <0.01 0.709 <0.01 <0.01 <0.01 0.884 0.405 0.349 <0.01 <0.01 0.760 0.63112. W.A. Spread 0.127 0.311 0.254 -0.16 0.157 0.540 -0.14 -0.04 0.000 -0.22 0.022 0.137 0.146 0.181 0.094 <0.01 <0.01 <0.01 <0.01 <0.01 <0.01 <0.01 0.064 0.964 <0.01 0.260 <0.01

<0.01 <0.01 <0.01

13. Covenant Dummy 0.066 0.116 -0.02 -0.00 0.102 0.112 -0.24 -0.02 0.074 0.131 -0.01 0.188 0.971 0.706 0.428 <0.01 <0.01 0.426 0.876 <0.01 <0.01 <0.01 0.218 <0.01 <0.01 0.656 <0.01 <0.01 <0.01 <0.0114. Liquidity Dummy 0.060 0.111 -0.01 0.009 0.093 0.107 -0.26 -0.02 0.073 0.120 -0.02 0.199 0.971 0.662 0.441 <0.01 <0.01 0.536 0.637 <0.01 <0.01 <0.01 0.366 <0.01 <0.01 0.305 <0.01 <0.01 <0.01

<0.01

15. Leverage Dummy 0.042 0.105 0.014 -0.07 0.117 0.184 -0.15 -0.06 0.035 0.066 0.037 0.252 0.706 0.662 0.308 0.029 <0.01 0.471 <0.01 <0.01 <0.01 <0.01 <0.01 0.071 <0.01 0.055 <0.01 <0.01 <0.01 <0.01

16. Net Worth Dummy 0.077 0.011 0.059 -0.04 -0.01 0.099 -0.01 0.137 -0.02 -0.00 0.026 0.120 0.428 0.441 0.308 <0.01 0.570 0.002 0.079 0.548 <0.01 0.456 <0.01 0.259 0.884 0.185 <0.01 <0.01 <0.01 <0.01

Table 4: Pearson (Upper Diagonal) and Spearman (Lower Diagonal) Correlations Among Variables

Footnote for Table 4: The sample consists of private loan packages, with interest rate spread and maturity information available in the 2005 Dealscan database, made to the family and non-family firms in the S&P 500 as identified in Business Week, November 10, 2003 (N=2,687). Variable definitions are as follows. Family Firm Dummy= 1 if firm is identified as a family firm by Business Week in its November 10, 2003, issue, else 0; Leverage: ratio of long-term debt to total assets (Compustat item # 51 / item # 44); Growth: book-to-market ratio (Compustat item # 59 /(item # 14 X item # 61); Firm Size: log of total assets (log of Compustat item # 44); Earnings Variability: the standard deviation of the ratio of annual operating income to total assets, computed using up to three years of historical data as available (Compustat item # 18 / item # 6); Credit Rating: S &P long-term domestic issuer credit rating from Compustat, coded 1 through 7 as follows: AAA=1; AA=2; A=3; BBB=4; BB=5; B=6; below B=7; LIBOR: the 12-month U.S. dollar denominated LIBOR rate as of June 30 of the current year; Financial Firm Dummy = 1 if the firm is in SIC 6000-6799, else 0; Deal Amount: deal size in US$; Weighted Average Maturity: the sum of the maturities of each facility in the package weighted by that facility’s proportion of the total deal amount; Weighted Average Spread: the sum of the amounts the borrower pays in basis points over LIBOR, inclusive of all fees for a deal, for each faculty in the package weighted by that facility’s proportion of the total deal amount; Covenant Dummy=1 if the loan package contains at least one financial covenant, else 0; and Liquidity, Leverage and Net Worth Dummies=1 if the loan package contains the specified covenant, else 0.

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Table 5: Basic Models: Panel A: Basic Probit Model: Prob (inclusion of at least one financial covenant) = F (β0 + β 1 Family Firm Dummy i + β 2 Leverage i

+ β 3 Growth i + β 4 Firm Size i + β 5 Earnings Variability i + β 6 Firm Credit Rating i + β 7 LIBOR i + β 8 Financial Firm Dummyi + β 9 Dual Class Dummy i + β 10 Deal Amount i

+ β 11 W.A .Maturity i + β12 W.A. Spread i + ζi )

Dependent Variable: Inclusion of at Least One Financial Covenant Explanatory Variables

(Predicted Sign) Without Dual Class Dummy

With Dual Class Dummy

Intercept 0.721 0.700 (0.006) (0.008) Family Firm Dummy (+) 0.207 0.179 (0.000) (0.002) Leverage (+) 0.590 0.538 (0.001) (0.003) Growth (-) -0.022 -0.011 (0.755) (0.873) Firm Size (-) -0.234 -0.231 (0.000) (0.000) Earnings Variability (+) 1.077 1.007 (0.154) (0.203) Firm Credit Rating (+) 0.130 0.132 (0.000) (0.000) LIBOR (-) -0.178 -0.178 (0.000) (0.000) Financial Firm Dummy (+/-) 0.105 0.095 (0.206) (0.253) Dual Class Dummy (+) 0.313 (0.003) Deal Amount (+) 11.60 11.60 (0.000) (0.000) W.A. Maturity (+) -0.002 -0.002 (0.077) (0.080) W.A. Spread (+/-) 0.0006 0.0006 (0.127) (0.106) Log Likelihood -1677.00 -1672.05 % correctly predicted 67.07% 67.18%

Footnote for Table 5 follows Panel C.

36

37

Panel B: Poisson and OLS Regressions for Covenant Intensity Index: Covenant Intensity Index = α0 + α 1 Family Firm Dummy i + α2 Leverage i + α3 Growth i + α4 Firm Size i + α 5 Earnings Variability i + α 6 Firm Credit Rating i + α 7 LIBOR i + α 8 Financial Firm Dummyi + α 9 Dual Class Dummy i + α 10 Deal Amount i + α 11 W.A .Maturity i + α12 W.A. Spread i + εi

Dependent Variable: Covenant Intensity Index (number of financial covenants included in loan package)

Poisson Regression OLS Regression Explanatory Variables (Predicted Sign) Without Dual

Class Dummy With Dual

Class Dummy Without Dual Class Dummy

With Dual Class Dummy

Intercept 0.967 0.957 1.882 1.866 (0.000) (0.000) (0.000) (0.000) Family Firm Dummy (+) 0.250 0.235 0.257 0.240 (0.000) (0.000) (0.000) (0.000) Leverage (+) 0.614 0.583 0.643 0.614 (0.000) (0.000) (0.001) (0.002) Growth (-) -0.005 -0.003 -0.009 -0.003 (0.916) (0.956) (0.906) (0.963) Firm Size (-) -0.353 -0.352 -0.322 -0.320 (0.000) (0.000) (0.000) (0.000) Earnings Variability (+) 0.459 0.412 0.597 0.564 (0.379) (0.437) (0.425) (0.464) Firm Credit Rating (+) 0.179 0.181 0.171 0.172 (0.000) (0.000) (0.000) (0.000) LIBOR (-) -0.158 -0.157 -0.157 -0.157 (0.000) (0.000) (0.000) (0.000) Financial Firm Dummy (+/-) 0.314 0.309 0.345 0.339 (0.000) (0.000) (0.000) (0.000) Dual Class Dummy (+) 0.153 0.187 (0.073) (0.080) Deal Amount (+) 8.810 8.690 8.670 8.590 (0.000) (0.000) (0.000) (0.000) W.A. Maturity (+) -0.0007 -0.0008 -0.0002 -0.0002 (0.459) (0.445) (0.829) (0.841) W.A. Spread (+/-) 0.001 0.001 0.002 0.002 (0.001) (0.000) (0.001) (0.000) Log Likelihood -3888.14 -3885.72 Pseudo R2 (Poisson)/ R2 (OLS) 0.074 0.075 0.130 0.131

Footnote for Table 5 follows Panel C.

Dependent Variable Liquidity Covenants

Leverage Covenants

Net Worth Covenants Explanatory Variables

(Predicted Sign) Without Dual Class Dummy

With Dual Class Dummy

Without Dual Class Dummy

With Dual Class Dummy

Without Dual Class Dummy

With Dual Class Dummy

Intercept 0.682 0.659 0.149 0.138 -1.164 -1.144 (0.010) (0.013) (0.580) (0.609) (0.000) (0.000)Family Firm Dummy (+) 0.193 0.165 0.078 0.064 0.230 0.248 (0.001) (0.004) (0.184) (0.288) (0.001) (0.000)Leverage (+) 0.554 0.501 0.348 0.325 -0.103 -0.076 (0.002) (0.005) (0.057) (0.078) (0.622) (0.721)Growth (-) -0.029 -0.018 -0.003 0.002 -0.006 -0.012 (0.684) (0.800) (0.969) (0.977) (0.931) (0.861)Firm Size (-) -0.212 -0.210 -0.302 -0.301 -0.201 -0.202 (0.000) (0.000) (0.000) (0.000) (0.001) (0.001)Earnings Variability (+) 0.905 0.836 0.622 0.586 -0.484 -0.442 (0.207) (0.264) (0.359) (0.398) (0.544) (0.587)Firm Credit Rating (+) 0.123 0.126 0.189 0.190 0.178 0.175 (0.000) (0.000) (0.000) (0.000) (0.000) (0.000)LIBOR (-) -0.187 -0.188 -0.130 -0.129 -0.028 -0.029 (0.000) (0.000) (0.000) (0.000) (0.059) (0.055)Financial Firm Dummy (+/-) 0.113 0.104 -0.029 -0.034 0.746 0.752 (0.173) (0.216) (0.765) (0.715) (0.000) (0.000)Dual Class Dummy (+) 0.321 0.158 -0.210 (0.002) (0.135) (0.142)Deal Amount (+) 10.50 10.50 7.64 7.56 4.37 4.48 (0.000) (0.000) (0.000) (0.000) (0.035) (0.031)W.A. Maturity (+) -0.002 -0.002 -0.0003 -0.0003 -0.0009 -0.0009 (0.057) (0.059) (0.779) (0.775) (0.402) (0.401)W.A. Spread (+/-) 0.0008 0.0008 0.001 0.001 0.0008 0.0008 (0.036) (0.029) (0.001) (0.001) (0.049) (0.059)

38

Panel C: Basic Probit Models for Specific Financial Covenants: Prob (the use of covenant) = F (β0 + β 1 Family Firm Dummy i + β 2 Leverage i + β 3 Growth i+ β 4 Firm Size i + β 5 Earnings Variability i + β 6 Firm Credit Rating i + β 7 LIBOR i + β 8 Financial Firm Dummy i + β 9 Dual Class Dummy i + β 10 Deal Amount i + β 11 W.A. Maturity i + β12 W.A. Spread i + ζi )

Log Likelihood -1655.14 -1649.98 -1461.05 -1459.88 -938.73 -937.45 % correctly predicted 68.80% 68.45% 74.31% 74.38% 87.86% 87.98%

Footnote for Table 5 is on the next page.

Footnote for Table 5: The sample consists of private loan packages, with interest rate spread and maturity information available in the 2005 Dealscan database, made to the family and non-family firms in the S&P 500 as identified in Business Week, November 10, 2003 (N=2,687). Variable definitions are as follows. Family Firm Dummy= 1 if firm is identified as a family firm by Business Week in its November 10, 2003, issue, else 0; Leverage: ratio of long-term debt to total assets (Compustat item # 51 / item # 44); Growth: book-to-market ratio (Compustat item # 59 /(item # 14 X item # 61); Firm Size: log of total assets (log of Compustat item # 44); Earnings Variability: the standard deviation of the ratio of annual operating income to total assets, computed using up to three years of historical data as available (Compustat item # 18 / item # 6); Firm Credit Rating: S &P long-term domestic issuer credit rating from Compustat, coded 1 through 7 as follows: AAA=1; AA=2; A=3; BBB=4; BB=5; B=6; below B=7; LIBOR: the 12-month U.S. dollar denominated LIBOR rate as of June 30 of the current year; Financial Firm Dummy = 1 if the firm is in SIC 6000-6799, else 0; Percent with Dual Class Stock: the percent of package for firms with classes of common stock with equal rights to cash flows but with unequal voting rights; Deal Amount: deal size in US$, coefficient multiplied by e+11; W.A. (Weighted Average) Maturity: the sum of the maturities of each facility in the package weighted by that facility’s proportion of the total deal amount; W.A. (Weighted Average) Spread: the sum of the amounts the borrower pays in basis points over LIBOR, inclusive of all fees for a deal, for each faculty in the package weighted by that facility’s proportion of the total deal amount; and covenant dummies=1 if the loan package contains the specified covenant, else 0. p-values are in parentheses below the coefficient.

39

Table 6: Basic Models with Outsider CEO Dummy Included: Panel A: Basic Probit Model with Outsider CEO Dummy Included: Prob (inclusion of at least one financial covenant) = F (β0 + β 1 Family Firm Dummy i + β 2 Outsider CEO Dummy i + β 3 Leverage i + β 4 Growth i + β 5 Firm Size i

+ β 6 Earnings Variability i + β 7 Firm Credit Rating i + β 8 LIBOR i + β 9 Financial Firm Dummyi + β 10 Dual Class Dummy i + β 11 Deal Amount i

+ β 12 W.A .Maturity i + β13 W.A. Spread i + ζi )

Dependent Variable: Inclusion of at Least One Financial Covenant Explanatory Variables

(Predicted Sign) Without Dual Class Dummy

With Dual Class Dummy

Intercept 0.726 0.708 (0.006) (0.008) Family Firm Dummy (+) 0.193 0.156 (0.007) (0.032) Outsider CEO Dummy (-) 0.029 0.048 (0.753) (0.599) Leverage (+) 0.594 0.545 (0.001) (0.002) Growth (-) -0.021 -0.010 (0.760) (0.883) Firm Size (-) -0.236 -0.235 (0.000) (0.000) Earnings Variability (+) 1.091 1.030 (0.150) (0.195) Firm Credit Rating (+) 0.130 0.132 (0.000) (0.000) LIBOR (-) -0.178 -0.178 (0.000) (0.000) Financial Firm Dummy (+/-) 0.108 0.101 (0.196) (0.231) Dual Class Dummy (+) 0.317 (0.002) Deal Amount (+) 11.60 11.60 (0.000) (0.000) W.A. Maturity (+) -0.002 -0.002 (0.077) (0.080) W.A. Spread (+/-) 0.0006 0.0006 (0.131) (0.111) Log Likelihood -1676.95 -1671.91 % correctly predicted 67.01% 67.03%

Footnote for Table 6 follows Panel C.

40

41

Panel B: Poisson and OLS Regressions for Covenant Intensity Index with Outsider CEO Dummy Included: Covenant Intensity Index = α0 + α 1 Family Firm Dummy i + α2 Outsider CEO Dummy i + α3 Leverage i + α4 Growth i + α5 Firm Size i + α 6 Earnings Variability i + α 7 Firm Credit Rating i + α 8 LIBOR i + α 9 Financial Firm Dummyi + α10 Dual Class Dummy i + α 11 Deal Amount i + α 12 W.A .Maturity i + α13 W.A. Spread i + εi

Dependent Variable: Covenant Intensity Index (number of financial covenants included in loan package)

Poisson Regression OLS Regression

Explanatory Variables (Predicted Sign) Without Dual

Class Dummy With Dual

Class Dummy Without Dual Class Dummy

With Dual Class Dummy

Intercept 0.953 0.944 1.863 1.850 (0.000) (0.000) (0.000) (0.000) Family Firm Dummy (+) 0.281 0.263 0.310 0.288 (0.000) (0.000) (0.000) (0.000) Outsider CEO Dummy (-) -0.065 -0.060 -0.110 -0.099 (0.428) (0.465) (0.268) (0.322) Leverage (+) 0.601 0.571 0.627 0.601 (0.000) (0.000) (0.001) (0.002) Growth (-) -0.007 -0.005 -0.011 -0.005 (0.880) (0.922) (0.886) (0.942) Firm Size (-) -0.347 -0.346 -0.314 -0.313 (0.000) (0.000) (0.000) (0.000) Earnings Variability (+) 0.436 0.392 0.546 0.520 (0.430) (0.459) (0.466) (0.500) Firm Credit Rating (+) 0.179 0.181 0.170 0.171 (0.000) (0.000) (0.000) (0.000) LIBOR (-) -0.158 -0.158 -0.158 -0.157 (0.000) (0.000) (0.000) (0.000) Financial Firm Dummy (+/-) 0.304 0.299 0.333 0.328 (0.000) (0.000) (0.000) (0.000) Dual Class Dummy (+) 0.151 0.179 (0.079) (0.097) Deal Amount (+) 8.79 8.68 8.68 8.60 (0.000) (0.000) (0.000) (0.000) W.A. Maturity (+) -0.0007 -0.0007 -0.0002 -0.0002 (0.464) (0.451) (0.838) (0.849) W.A. Spread (+/-) 0.001 0.001 0.002 0.002 (0.001) (0.000) (0.000) (0.000) Log Likelihood -3887.63 -3885.28 Pseudo R2 (Poisson)/ R2 (OLS) 0.074 0.075 0.130 0.132

Footnote for Table 6 follows Panel C.

42

Panel C: Basic Probit Models for Specific Financial Covenants with Outsider CEO Dummy Included: Prob (the use of covenant) = F (β0 + β 1 Family Firm Dummy i + β 2 Outsider CEO Dummy i + β 3 Leverage i + β 4 Growth i + β 5 Firm Size i + β 6 Earnings Variability i + β 7 Firm Credit Rating i + β 8 LIBOR i + β 9 Financial Firm Dummy i + β 10 Dual Class Dummy i + β 11 Deal Amount i + β 12 W.A. Maturity i + β13 W.A. Spread i + ζi )

Dependent Variable Liquidity Covenants

Leverage Covenants

Net Worth Covenants Explanatory Variables

(Predicted Sign) Without Dual Class Dummy

With Dual Class Dummy

Without Dual Class Dummy

With Dual Class Dummy

Without Dual Class Dummy

With Dual Class Dummy

Intercept 0.683 0.664 0.136 0.126 -1.216 -1.195 (0.010) (0.012) (0.614) (0.640) (0.000) (0.000)Family Firm Dummy (+) 0.190 0.152 0.108 0.091 0.336 0.363 (0.008) (0.038) (0.155) (0.241) (0.000) (0.000)Outsider CEO Dummy 0.006 0.026 -0.064 -0.058 -0.244 -0.261 (0.947) (0.781) (0.511) (0.549) (0.030) (0.020)Leverage (+) 0.555 0.504 0.338 0.317 -0.144 -0.116 (0.002) (0.005) (0.065) (0.086) (0.492) (0.587)Growth (-) -0.029 -0.017 -0.004 0.000 -0.010 -0.017 (0.685) (0.805) (0.951) (0.995) (0.888) (0.811)Firm Size (-) -0.213 -0.212 -0.297 -0.296 -0.181 -0.181 (0.000) (0.000) (0.000) (0.000) (0.004) (0.004)Earnings Variability (+) 0.908 0.847 0.596 0.562 -0.576 -0.543 (0.207) (0.259) (0.380) (0.417) (0.471) (0.509)Firm Credit Rating (+) 0.123 0.126 0.189 0.190 0.176 0.173 (0.000) (0.000) (0.000) (0.000) (0.000) (0.000)LIBOR (-) -0.187 -0.187 -0.130 -0.130 -0.030 -0.031 (0.000) (0.000) (0.000) (0.000) (0.045) (0.042)Financial Firm Dummy (+/-) 0.114 0.106 -0.036 -0.040 0.719 0.724 (0.174) (0.208) (0.702) (0.668) (0.000) (0.000)Dual Class Dummy (+) 0.323 0.156 -0.236 (0.002) (0.143) (0.098)Deal Amount (+) 10.50 10.50 7.63 7.55 4.34 4.46 (0.000) (0.000) (0.000) (0.000) (0.036) (0.031)W.A. Maturity (+) -0.002 -0.002 -0.0003 -0.0003 -0.0009 -0.0009 (0.057) (0.059) (0.784) (0.779) (0.411) (0.406)W.A. Spread (+/-) 0.0008 0.0008 0.001 0.001 0.0008 0.0008 (0.037) (0.030) (0.001) (0.001) (0.039) (0.047) Log Likelihood -1655.14 -1649.94 -1460.83 -1459.69 -936.30 -934.71 % correctly predicted 68.80% 68.51% 74.26% 74.32% 88.10% 88.13%

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Footnote for Table 6: The sample consists of private loan packages, with interest rate spread and maturity information available in the 2005 Dealscan database, made to the family and non-family firms in the S&P 500 as identified in Business Week, November 10, 2003 (N=2,687). Variable definitions are as follows. Family Firm Dummy= 1 if firm is identified as a family firm by Business Week in its November 10, 2003, issue, else 0; Outsider CEO Dummy=1 if the CEO is a non-family member at the inception of the loan package; Leverage: ratio of long-term debt to total assets (Compustat item # 51 / item # 44); Growth: book-to-market ratio (Compustat item # 59 /(item # 14 X item # 61); Firm Size: log of total assets (log of Compustat item # 44); Earnings Variability: the standard deviation of the ratio of annual operating income to total assets, computed using up to three years of historical data as available (Compustat item # 18 / item # 6); Firm Credit Rating: S &P long-term domestic issuer credit rating from Compustat, coded 1 through 7 as follows: AAA=1; AA=2; A=3; BBB=4; BB=5; B=6; below B=7; LIBOR: the 12-month U.S. dollar denominated LIBOR rate as of June 30 of the current year; Financial Firm Dummy = 1 if the firm is in SIC 6000-6799, else 0; Percent with Dual Class Stock: the percent of package for firms with classes of common stock with equal rights to cash flows but with unequal voting rights; Deal Amount: deal size in US$, coefficient multiplied by e+11; W.A. (Weighted Average) Maturity: the sum of the maturities of each facility in the package weighted by that facility’s proportion of the total deal amount; W.A. (Weighted Average) Spread: the sum of the amounts the borrower pays in basis points over LIBOR, inclusive of all fees for a deal, for each faculty in the package weighted by that facility’s proportion of the total deal amount; and covenant dummies=1 if the loan package contains the specified covenant, else 0. p-values are in parentheses below the coefficient.

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Table 7: 2SCML Model: (Second–stage Probit) Prob (covenant) = F (β0 + β 1 Family Firm Dummy i + β 2 Leverage i + β 3 Growth i + β 4 Firm Size i + β 5 Earnings Variability i + β 6 Firm Credit Rating i + β 7 LIBOR i + β 8 Financial Firm Dummy i + β 9 Dual Class Dummy i + β 10 Deal Amount i + β 11 W.A. Maturity i + β12 W.A. Spread i + β 13 Spread Residual + ζi )

Dependent Variable (Type of Covenant) At Least One

Financial Covenant Liquidity

Covenants Leverage

Covenants Net Worth Covenants Explanatory Variables

(Predicted Sign) Without Dual Class

Dummy

With Dual Class

Dummy

Without Dual Class

Dummy

With Dual Class

Dummy

Without Dual Class

Dummy

With Dual Class

Dummy

Without Dual Class

Dummy

With Dual Class

Dummy Intercept 0.727 0.704 0.692 0.665 0.154 0.143 -1.152 -1.134 (0.006) (0.008) (0.009) (0.012) (0.566) (0.597) (0.000) (0.000)Family Firm Dummy (+) 0.169 0.141 0.139 0.108 0.055 0.039 0.186 0.201 (0.003) (0.016) (0.016) (0.066) (0.360) (0.531) (0.008) (0.005)Leverage (+) 0.206 0.156 0.002 -0.062 0.123 0.087 -0.566 -0.550 (0.340) (0.473) (0.994) (0.778) (0.582) (0.698) (0.024) (0.031)Growth (-) -0.100 -0.087 -0.141 -0.130 -0.049 -0.046 -0.104 -0.111 (0.181) (0.239) (0.062) (0.083) (0.504) (0.526) (0.170) (0.141)Firm Size (-) -0.198 -0.196 -0.161 -0.157 -0.281 -0.278 -0.155 -0.155 (0.001) (0.001) (0.004) (0.006) (0.000) (0.000) (0.014) (0.014)Earnings Variability (+) 0.366 0.303 -0.117 -0.201 0.202 0.142 -1.395 -1.371 (0.646) (0.715) (0.878) (0.800) (0.780) (0.847) (0.094) (0.106)Firm Credit Rating (+) 0.066 0.069 0.032 0.034 0.151 0.151 0.098 0.094 (0.069) (0.056) (0.379) (0.351) (0.000) (0.000) (0.027) (0.035)LIBOR (-) -0.164 -0.165 -0.168 -0.168 -0.121 -0.121 -0.011 -0.012 (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.470) (0.463)Financial Firm Dummy (+/-) 0.067 0.057 0.059 0.047 -0.052 -0.058 0.698 0.702 (0.421) (0.495) (0.482) (0.575) (0.577) (0.531) (0.000) (0.000)Dual Class Dummy (+) 0.333 0.351 0.170 -0.188 (0.001) (0.001) (0.109) (0.191) Deal Amount (+) 11.80 11.80 10.90 10.90 7.75 7.67 4.50 4.60 (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.028) (0.024)W.A. Maturity (+) -0.002 -0.002 -0.002 -0.002 -0.0003 -0.0003 -0.0009 -0.0009 (0.088) (0.092) (0.067) (0.070) (0.782) (0.779) (0.409) (0.414)W.A. Spread (+/-) 0.003 0.003 0.005 0.005 0.003 0.003 0.004 0.004 (0.000) (0.000) (0.000) (0.000) (0.003) (0.002) (0.000) (0.000)Spread Residual -0.003 -0.003 -0.004 -0.004 -0.002 -0.002 -0.004 -0.004 (0.002) (0.002) (0.000) (0.000) (0.081) (0.067) (0.000) (0.000) Log Likelihood -1672.19 -1667.39 -1645.31 -1639.99 -1459.43 -1458.09 -933.50 -932.04% correctly predicted 67.38% 67.05% 68.85% 68.16% 74.29% 74.29% 88.10% 88.10%

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Footnote for Table 7: The sample consists of private loan packages, with interest rate spread and maturity information available in the 2005 Dealscan database, made to the family and non-family firms in the S&P 500 as identified in Business Week, November 10, 2003 (N=2,687). Variable definitions are as follows. Family Firm Dummy= 1 if firm is identified as a family firm by Business Week in its November 10, 2003, issue, else 0; Leverage: ratio of long-term debt to total assets (Compustat item # 51 / item # 44); Growth: book-to-market ratio (Compustat item # 59 /(item # 14 X item # 61); Firm Size: log of total assets (log of Compustat item # 44); Earnings Variability: the standard deviation of the ratio of annual operating income to total assets, computed using up to three years of historical data as available (Compustat item # 18 / item # 6); Firm Credit Rating: S &P long-term domestic issuer credit rating from Compustat, coded 1 through 7 as follows: AAA=1; AA=2; A=3; BBB=4; BB=5; B=6; below B=7; LIBOR: the 12-month U.S. dollar denominated LIBOR rate as of June 30 of the current year; Financial Firm Dummy = 1 if the firm is in SIC 6000-6799, else 0; Percent with Dual Class Stock: the percent of package for firms with classes of common stock with equal rights to cash flows but with unequal voting rights; Deal Amount: deal size in US$, coefficient multiplied by e+11; W.A. (Weighted Average) Maturity: the sum of the maturities of each facility in the package weighted by that facility’s proportion of the total deal amount; W.A. (Weighted Average) Spread: the sum of the amounts the borrower pays in basis points over LIBOR, inclusive of all fees for a deal, for each faculty in the package weighted by that facility’s proportion of the total deal amount; Spread Residual: the residuals from the first-stage reduced form OLS regression with average spread as the dependent variable and all explanatory variables from the basic probit regressions in Tables 5 and 6 except the (endogenous) W.A. Spread variable, plus a dummy variable for whether the debt is secured and another for the existence of other covenants as independent variables; and covenant dummies=1 if the loan package contains the specified covenant, else 0. p-values are in parentheses below the coefficient.

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Table 8: 2SCML Models with Outsider CEO Dummy Included: (Second-stage Probit) Prob (covenant) = F (β0 + β 1 Family Firm Dummy i + β 2 Outsider CEO i + β 3 Leverage i + β 4 Growth i + β 5 Firm Size i + β 6 Earnings Variability i + β 7 Firm Credit Rating i + β 8 LIBOR i + β 9 Financial Firm Dummy i + β 10 Dual Class Dummy i + β 11 Deal Amount i + β 12 W.A. Maturity i + β13 W.A. Spread i + β 14 Spread Residual + ζi )

Dependent Variable (Type of Covenant) At Least One

Financial Covenant Liquidity

Covenants Leverage

Covenants Net Worth Covenants Explanatory Variables

(Predicted Sign) Without Dual Class

Dummy

With Dual Class

Dummy

Without Dual Class

Dummy

With Dual Class

Dummy

Without Dual Class

Dummy

With Dual Class

Dummy

Without Dual Class

Dummy

With Dual Class

Dummy Intercept 0.729 0.709 0.687 0.665 0.139 0.129 -1.207 -1.189 (0.006) (0.007) (0.009) (0.012) (0.606) (0.634) (0.000) (0.000)Family Firm Dummy (+) 0.167 0.128 0.152 0.110 0.092 0.073 0.306 0.330 (0.021) (0.083) (0.038) (0.139) (0.232) (0.354) (0.000) (0.000)Outsider CEO Dummy (-) 0.005 0.026 -0.029 -0.007 -0.079 -0.074 -0.276 -0.292 (0.954) (0.774) (0.754) (0.936) (0.416) (0.450) (0.015) (0.009)Leverage (+) 0.206 0.159 -0.020 -0.079 0.107 0.073 -0.621 -0.603 (0.340) (0.465) (0.928) (0.720) (0.635) (0.746) (0.014) (0.019)Growth (-) -0.100 -0.087 -0.145 -0.133 -0.052 -0.049 -0.110 -0.118 (0.182) (0.241) (0.055) (0.075) (0.480) (0.504) (0.147) (0.119)Firm Size (-) -0.198 -0.198 -0.157 -0.155 -0.274 -0.272 -0.132 -0.130 (0.001) (0.001) (0.006) (0.007) (0.000) (0.000) (0.038) (0.040)Earnings Variability (+) 0.369 0.316 -0.162 -0.234 0.159 0.105 -1.515 -1.497 (0.644) (0.705) (0.833) (0.769) (0.826) (0.887) (0.069) (0.080)Firm Credit Rating (+) 0.066 0.070 0.029 0.031 0.150 0.150 0.094 0.090 (0.069) (0.056) (0.427) (0.391) (0.000) (0.000) (0.035) (0.046)LIBOR (-) -0.164 -0.165 -0.168 -0.168 -0.122 -0.121 -0.013 -0.014 (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.404) (0.393)Financial Firm Dummy (+/-) 0.068 0.060 0.054 0.045 -0.061 -0.067 0.666 0.670 (0.422) (0.477) (0.523) (0.597) (0.517) (0.479) (0.000) (0.000)Dual Class Dummy (+) 0.336 0.352 0.167 -0.215 (0.001) (0.001) (0.118) (0.134)Deal Amount (+) 11.80 11.80 10.90 10.90 7.74 7.66 4.49 4.60 (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.027) (0.024)W.A. Maturity (+) -0.002 -0.002 -0.002 -0.002 -0.0003 -0.0003 -0.0009 -0.0009 (0.088) (0.093) (0.067) (0.071) (0.787) (0.784) (0.417) (0.417)W.A. Spread (+/-) 0.003 0.003 0.005 0.005 0.003 0.003 0.004 0.004 (0.000) (0.000) (0.000) (0.000) (0.003) (0.002) (0.000) (0.000)Spread Residual -0.003 -0.003 -0.005 -0.005 -0.002 -0.002 -0.004 -0.004 (0.002) (0.002) (0.000) (0.000) (0.074) (0.063) (0.000) (0.000)Log Likelihood -1672.14 -1667.25 -1644.68 -1639.38 -1459.13 -1457.84 -930.87 -929.11% correctly predicted 67.40% 67.32% 68.85% 68.11% 74.25% 74.35% 88.10% 88.10%

Footnote for Table 8: The sample consists of private loan packages, with interest rate spread and maturity information available in the 2005 Dealscan database, made to the family and non-family firms in the S&P 500 as identified in Business Week, November 10, 2003 (N=2,687). Variable definitions are as follows. Family Firm Dummy= 1 if firm is identified as a family firm by Business Week in its November 10, 2003, issue, else 0; Outsider CEO Dummy=1 if the CEO is a non-family member at the inception of the loan package; Leverage: ratio of long-term debt to total assets (Compustat item # 51 / item # 44); Growth: book-to-market ratio (Compustat item # 59 /(item # 14 X item # 61); Firm Size: log of total assets (log of Compustat item # 44); Earnings Variability: the standard deviation of the ratio of annual operating income to total assets, computed using up to three years of historical data as available (Compustat item # 18 / item # 6); Firm Credit Rating: S &P long-term domestic issuer credit rating from Compustat, coded 1 through 7 as follows: AAA=1; AA=2; A=3; BBB=4; BB=5; B=6; below B=7; LIBOR: the 12-month U.S. dollar denominated LIBOR rate as of June 30 of the current year; Financial Firm Dummy = 1 if the firm is in SIC 6000-6799, else 0; Percent with Dual Class Stock: the percent of package for firms with classes of common stock with equal rights to cash flows but with unequal voting rights; Deal Amount: deal size in US$, coefficient multiplied by e+11; W.A. (Weighted Average) Maturity: the sum of the maturities of each facility in the package weighted by that facility’s proportion of the total deal amount; W.A. (Weighted Average) Spread: the sum of the amounts the borrower pays in basis points over LIBOR, inclusive of all fees for a deal, for each faculty in the package weighted by that facility’s proportion of the total deal amount; Spread Residual: the residuals from the first-stage reduced form OLS regression with average spread as the dependent variable and all explanatory variables from the basic probit regressions in Tables 5 and 6 except the (endogenous) W.A. Spread variable, plus a dummy variable for whether the debt is secured and another for the existence of other covenants as independent variables; and covenant dummies=1 if the loan package contains the specified covenant, else 0. p-values are in parentheses below the coefficient.

47