Question

Briefly explain how shareholders’ control rights differ from the influence that lenders gain through debt covenants

Answer 1

Shareholders by definition hold a share of the company and are thus the owners of the company. Thus they have right in the gains of the company and also loose their investment in the event of loss for the company. Thus the opportunities for gains and risks for losses are both high.

Debtholders on the other hand are creditors to the company who have given the company's management some funds for some purpose. Debtholders relationship with the firm is from and until their funds are with the firm. Once the firm repays the funds to the debtholders, they have no role in the firm any more. Thus if the firm does well and makes gains, the debtholders has higher chances of getting their princi6and interest repaid. But their gain is limited to the principal and interest amount and nothing more. If the event of loss, the debtholders is usually protected and will be repaid by liquidating the firm assets and thus risks is limited to be a debtholder.

Debt covenants work in the case of payment to be made to debtholders in the event of bankruptcy or some emergency. On a normal working environment, the debt covenants do not have any control rather it's the shareholders voting rights which decide the mode of operation of the firm.

Thus shareholders voting rights have role in everyday working decisions of the firm while the risks of a debtholder through covenants are more relevant in the case of bankruptcy for being repaid.