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Covenant violations and dynamic loan contracting

Author

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  • Freudenberg, Felix
  • Imbierowicz, Björn
  • Saunders, Anthony
  • Steffen, Sascha

Abstract

This paper examines the dynamic allocation of control rights in private debt contracts of firms. We show that a covenant violation in the prior loan contract implies a stigma for borrowers which results in stricter loan contract terms in subsequent new loan contracts. Our analyses reject potentially other explanations such as firm characteristics or agency problems between the lender and firm management, shareholders or public debtholders. After covenant violations in the prior contract, new loans have on average 18bps higher spreads and include more of those covenant types which also have been violated in the prior contract, with tighter thresholds.

Suggested Citation

  • Freudenberg, Felix & Imbierowicz, Björn & Saunders, Anthony & Steffen, Sascha, 2017. "Covenant violations and dynamic loan contracting," Journal of Corporate Finance, Elsevier, vol. 45(C), pages 540-565.
    • Handle: RePEc:eee:corfin:v:45:y:2017:i:c:p:540-565
    DOI: 10.1016/j.jcorpfin.2017.05.009
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    More about this item

    Keywords

    Control rights; Covenant violation; Dynamic loan contracting; Stigma;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation

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