IDEAS home Printed from https://ideas.repec.org/p/rba/rbardp/rdp2022-05.html
   My bibliography  Save this paper

The Real Effects of Debt Covenants: Evidence from Australia

Author

Listed:
  • Kim Nguyen

    (Reserve Bank of Australia)

Abstract

I study how the use and structure of debt covenants affect real business activity and pass-through of monetary policy using a newly constructed dataset of corporate debt covenants in Australia. I find that exposure to debt covenants disciplines firms' investment and staff expenses even in the absence of covenant breaches. In addition, covenants with interest coverage limits appear to amplify the transmission of monetary policy shocks while other types of covenants appear to mitigate transmission. As such, the shift from interest coverage limits to other types of covenants that appears to have occurred since the late 2000s may have lowered the responsiveness of investment to monetary policy, and in turn accounted for some of the surprising weakness in non-mining investment over the past decade.

Suggested Citation

  • Kim Nguyen, 2022. "The Real Effects of Debt Covenants: Evidence from Australia," RBA Research Discussion Papers rdp2022-05, Reserve Bank of Australia.
    • Handle: RePEc:rba:rbardp:rdp2022-05
    DOI: 10.47688/rdp2022-05
    as

    Download full text from publisher

    File URL: https://www.rba.gov.au/publications/rdp/2022/pdf/rdp2022-05.pdf
    Download Restriction: no
    File URL: https://libkey.io/10.47688/rdp2022-05?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    References listed on IDEAS

    as
    1. Daniel Greenwald, 2019. "Firm Debt Covenants and the Macroeconomy: The Interest Coverage Channel," 2019 Meeting Papers 520, Society for Economic Dynamics.
    2. Antonio Falato & Nellie Liang, 2016. "Do Creditor Rights Increase Employment Risk? Evidence from Loan Covenants," Journal of Finance, American Finance Association, vol. 71(6), pages 2545-2590, December.
    3. Alexander Ballantyne & Tom Cusbert & Richard Evans & Rochelle Guttmann & Jonathan Hambur & Adam Hamilton & Elizabeth Kendall & Rachael McCririck & Gabriela Nodari & Daniel M. Rees, 2020. "MARTIN Has Its Place: A Macroeconometric Model of the Australian Economy," The Economic Record, The Economic Society of Australia, vol. 96(314), pages 225-251, September.
    4. Jyrki Niskanen & Mervi Niskanen, 2004. "Covenants and Small Business Lending: The Finnish Case," Small Business Economics, Springer, vol. 23(2), pages 137-149, September.
    5. Òscar Jordà & Alan M. Taylor, 2016. "The Time for Austerity: Estimating the Average Treatment Effect of Fiscal Policy," Economic Journal, Royal Economic Society, vol. 126(590), pages 219-255, February.
    6. Matias D. Cattaneo & Michael Jansson & Xinwei Ma, 2020. "Simple Local Polynomial Density Estimators," Journal of the American Statistical Association, Taylor & Francis Journals, vol. 115(531), pages 1449-1455, July.
    7. Agrawal, Ashwini K. & Matsa, David A., 2013. "Labor unemployment risk and corporate financing decisions," Journal of Financial Economics, Elsevier, vol. 108(2), pages 449-470.
    8. Sudheer Chava & Michael R. Roberts, 2008. "How Does Financing Impact Investment? The Role of Debt Covenants," Journal of Finance, American Finance Association, vol. 63(5), pages 2085-2121, October.
    9. Philippe Aghion & Patrick Bolton, 1992. "An Incomplete Contracts Approach to Financial Contracting," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 59(3), pages 473-494.
    10. KOCHIYAMA, Takuma & NAKAMURA, Ryosuke, 2014. "Role, Structure, and Determinants of Debt Covenants: Evidence from Japan," Working Paper Series 187, Center for Japanese Business Studies (HJBS), Graduate School of Commerce and Management Hitotsubashi University.
    11. Dario Caldara & Edward Herbst, 2019. "Monetary Policy, Real Activity, and Credit Spreads: Evidence from Bayesian Proxy SVARs," American Economic Journal: Macroeconomics, American Economic Association, vol. 11(1), pages 157-192, January.
    12. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, vol. 3(4), pages 305-360, October.
    13. Hans B. Christensen & Valeri V. Nikolaev, 2012. "Capital Versus Performance Covenants in Debt Contracts," Journal of Accounting Research, Wiley Blackwell, vol. 50(1), pages 75-116, March.
    14. Jean Tirole, 2006. "The Theory of Corporate Finance," Post-Print hal-00173191, HAL.
    15. Ilia D. Dichev & Douglas J. Skinner, 2002. "Large–Sample Evidence on the Debt Covenant Hypothesis," Journal of Accounting Research, Wiley Blackwell, vol. 40(4), pages 1091-1123, September.
    16. Michael Bradley & Michael R. Roberts, 2015. "The Structure and Pricing of Corporate Debt Covenants," Quarterly Journal of Finance (QJF), World Scientific Publishing Co. Pte. Ltd., vol. 5(02), pages 1-37.
    17. Benjamin Beckers, 2020. "Credit Spreads, Monetary Policy and the Price Puzzle," RBA Research Discussion Papers rdp2020-01, Reserve Bank of Australia.
    18. Lance Moir & Sudi Sudarsanam, 2007. "Determinants of financial covenants and pricing of debt in private debt contracts: the UK evidence," Accounting and Business Research, Taylor & Francis Journals, vol. 37(2), pages 151-166.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Kim Nguyen & Jonathan Hambur, 2023. "Adoption of Emerging Digital General-purpose Technologies: Determinants and Effects," RBA Research Discussion Papers rdp2023-10, Reserve Bank of Australia.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Falk Bräuning & Victoria Ivashina & Ali Ozdagli, 2022. "High-Yield Debt Covenants and Their Real Effects," Working Papers 22-5, Federal Reserve Bank of Boston.
    2. Daher, Mai M. & Ismail, Ahmad K., 2018. "Debt covenants and corporate acquisitions," Journal of Corporate Finance, Elsevier, vol. 53(C), pages 174-201.
    3. Gabriel Chodorow‐Reich & Antonio Falato, 2022. "The Loan Covenant Channel: How Bank Health Transmits to the Real Economy," Journal of Finance, American Finance Association, vol. 77(1), pages 85-128, February.
    4. Theodore E. Christensen & Hang Pei & Spencer R. Pierce & Liang Tan, 2019. "Non-GAAP reporting following debt covenant violations," Review of Accounting Studies, Springer, vol. 24(2), pages 629-664, June.
    5. Michael R. Roberts & Michael Schwert, 2020. "Interest Rates and the Design of Financial Contracts," NBER Working Papers 27195, National Bureau of Economic Research, Inc.
    6. Dan A. Iancu & Nikolaos Trichakis & Gerry Tsoukalas, 2017. "Is Operating Flexibility Harmful Under Debt?," Management Science, INFORMS, vol. 63(6), pages 1730-1761, June.
    7. Shazia, Farhan, 2024. "Crime and covenants," International Review of Financial Analysis, Elsevier, vol. 94(C).
    8. Christensen, Hans B. & Macciocchi, Daniele & Morris, Arthur & Nikolaev, Valeri V., 2022. "Financial shocks to lenders and the composition of financial covenants," Journal of Accounting and Economics, Elsevier, vol. 73(1).
    9. Björn Imbierowicz & Daniel Streitz, 2024. "Financial debt contracting and managerial agency problems," Financial Management, Financial Management Association International, vol. 53(1), pages 99-118, March.
    10. Thomas Drechsel, 2023. "Earnings-Based Borrowing Constraints and Macroeconomic Fluctuations," American Economic Journal: Macroeconomics, American Economic Association, vol. 15(2), pages 1-34, April.
    11. Takuma Kochiyama & Ryosuke Nakamura & Akinobu Shuto, 2021. "How do bank lenders use borrowers’ financial statements? Evidence from a survey of Japanese banks," CARF F-Series CARF-F-522, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo.
    12. Antonio Falato & Nellie Liang, 2016. "Do Creditor Rights Increase Employment Risk? Evidence from Loan Covenants," Journal of Finance, American Finance Association, vol. 71(6), pages 2545-2590, December.
    13. Nuri Ersahin & Rustom M. Irani & Hanh Le, 2015. "Creditor Control Rights and Resource Allocation within Firms," Working Papers 15-39, Center for Economic Studies, U.S. Census Bureau.
    14. Devos, Erik & Rahman, Shofiqur & Tsang, Desmond, 2017. "Debt covenants and the speed of capital structure adjustment," Journal of Corporate Finance, Elsevier, vol. 45(C), pages 1-18.
    15. Daher, Mai, 2017. "Creditor control rights, capital structure, and legal enforcement," Journal of Corporate Finance, Elsevier, vol. 44(C), pages 308-330.
    16. Keil, Jan, 2023. "Lending relationships when creditors are in control," Journal of Corporate Finance, Elsevier, vol. 79(C).
    17. Tan, Liang, 2013. "Creditor control rights, state of nature verification, and financial reporting conservatism," Journal of Accounting and Economics, Elsevier, vol. 55(1), pages 1-22.
    18. Chy, Mahfuz & Kyung, Hoyoun, 2023. "The effect of bond market transparency on bank loan contracting," Journal of Accounting and Economics, Elsevier, vol. 75(2).
    19. Bazzana, Flavio & Zadorozhnaya, Anna & Gabriele, Roberto, 2018. "The role of covenants in bond issue. The case of Russian companies," Emerging Markets Review, Elsevier, vol. 36(C), pages 1-18.
    20. Aiyesha Dey & Valeri Nikolaev & Xue Wang, 2016. "Disproportional Control Rights and the Governance Role of Debt," Management Science, INFORMS, vol. 62(9), pages 2581-2614, September.

    More about this item

    Keywords

    debt covenants; financing friction; investment; employment; monetary policy;
    All these keywords.

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets
    • E2 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:rba:rbardp:rdp2022-05. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Paula Drew (email available below). General contact details of provider: https://edirc.repec.org/data/rbagvau.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.