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Initial Technical Violations of Debt Covenants and Changes in Firm Risk

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  • Neil L. Fargher
  • Michael S. Wilkins
  • Lori M. Holder‐Webb

Abstract

The purpose of this paper is to investigate whether initial technical debt covenant violations are associated with significant increases in the equity risk of violating firms. Our results indicate that first‐time violations are associated with significant increases in both systematic and unsystematic risk. The increase in systematic risk is attributable primarily to rising levels of financial leverage as opposed to changes in the underlying asset beta. We also find that the change in unsystematic risk experienced by first‐time debt covenant violators is a significant predictor of future exchange delisting, even after controlling for other factors typically associated with increasing financial distress.

Suggested Citation

  • Neil L. Fargher & Michael S. Wilkins & Lori M. Holder‐Webb, 2001. "Initial Technical Violations of Debt Covenants and Changes in Firm Risk," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 28(3‐4), pages 465-480, April.
    • Handle: RePEc:bla:jbfnac:v:28:y:2001:i:3-4:p:465-480
    DOI: 10.1111/1468-5957.00381
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    Cited by:

    1. Umar Butt, 2019. "Debt covenant violation, competition and cost of new debt," Australian Journal of Management, Australian School of Business, vol. 44(2), pages 163-187, May.
    2. Xu Chong Bo & Wenyi Li & Jing Shi & Yi Zheng & Qing Zhou, 2021. "Relationship lending and bank loan covenant violations," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 61(4), pages 5847-5878, December.
    3. Chenchuramaiah T. Bathala & Oswald D. Bowlin & William P. Dukes, 2006. "Use of Debt Covenants in Small Firms," Journal of Entrepreneurial Finance, Pepperdine University, Graziadio School of Business and Management, vol. 11(2), pages 49-72, Summer.

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