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Covenant violation and operational efficiency

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  • Hui Liang James
  • Hongxia Wang
  • Zhimin Wang

Abstract

We examine the impact of covenant violation on corporate operational efficiency. Using an aggregate measure of operational efficiency developed by Demerjian et al. (Management Science, 58, 2012, 1229–1248), we provide strong empirical evidence that covenant violations hinder firms from achieving operational efficiency. Our finding is robust to alternative definitions of operational efficiency and various model specifications to address potential endogeneity issues. Further analyses show that lower operational efficiency is attributable to covenant‐violating firms' under‐investments in capital and labour. In addition, the negative effect of covenant violation on operational efficiency is not universally the same, and is less evident in violating firms with greater agency problems.

Suggested Citation

  • Hui Liang James & Hongxia Wang & Zhimin Wang, 2024. "Covenant violation and operational efficiency," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 64(2), pages 1879-1920, June.
    • Handle: RePEc:bla:acctfi:v:64:y:2024:i:2:p:1879-1920
    DOI: 10.1111/acfi.13204
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