The Roles of Acceleration

Acceleration clauses are found in most debt instruments. Upon the occurrence of predetermined triggering event, acceleration makes a creditor's future claim due and payable. While debt covenants have been analyzed extensively in the academic literature, the role of acceleration has been overlooked.This paper examines the role of acceleration clauses and maintains that they play a critical role in debt financing. The paper argues that the prime role of acceleration is to perfect a complex set of governance mechanisms within the corporate setting. This governance role is comprised of three parts. First, acceleration is a complementary measure that supports debt covenants in mitigating ex ante the borrower's agency costs of self-interest actions. The other two parts of the governance mechanism function ex post, upon the debtor's financial distress. Each deals with disciplining a different entity that may generate wasteful costs to the creditor. One entity that requires restraining is the debtor. Acceleration facilitates the commencement of the debtor's bankruptcy and thus curtails any prospective losses to the creditors resulting from the borrower's continuous moral hazard. The other entity a creditor must worry about, which has been widely neglected by the financial literature, is other, self-interested, creditors who rush to dismantle the common debtor upon the latter's financial distress. Cross-acceleration clauses place all creditors on equal footing, establish an inter-creditor balance of terror, and prevent the creditors from liquidating the firm prematurely. Instead, cross-acceleration leads the creditors to engage in collective negotiations and work out a comprehensive restructuring of the firm's finance