We examine the impact of creditor control rights on corporate acquisitions. Nearly 75% of loan agreements include restrictions that limit borrower acquisition decisions throughout the life of the contract. Following a financial covenant violation, creditors use their bargaining power to tighten these restrictions and limit acquisition activity, particularly deals expected to earn negative announcement returns. Firms that do announce an acquisition after violating a financial covenant earn 1.8% higher stock returns, on average, and do not pursue less risky deals. We conclude that creditors use contractual rights and the renegotiation process to limit value-destroying acquisitions driven by managerial agency problems.

We use a threshold-based design to study ex post discretion in lenders’ contractual enforcement of covenant violations. At preset thresholds, lenders enforce contractual breaches only infrequently, but this enforcement is associated with material consequences (e.g., fees and renegotiations). Enforcement varies significantly over time and peaks when credit conditions are tightest, indicating that enforcement is procyclical. Costly coordination reduces enforcement: Syndicates with ex ante restrictive voting requirements enforce at lower rates. Consistent with theories of lender competition and implicit contracting, enforcement rates are lower for borrowers with access to alternative sources of financing and well-reputed lead arrangers.

To meet short-term benchmarks, lenders may alter their monitoring behavior, providing a channel for short-termism to spill over to their borrowers. We find that short-termist lenders are significantly more likely to enforce covenant breaches. This behavior is pronounced when performance benchmarks are precise or salient, and when managers have high pay-performance sensitivity, but not when they face strong shareholder governance. Affected borrowers are more likely to switch lenders, pay higher spreads on renegotiated loans, and reduce investment. Our findings suggest that bank managers trade off relationship capital for income-boosting fees and term changes from covenant enforcement to meet earnings benchmarks.