High-Yield Debt Covenants and Their Real Effects

Falk Bräuning, Victoria Ivashina and Ali Ozdagli

No 2311, Working Papers from Federal Reserve Bank of Dallas

Abstract: High-yield debt, including leveraged loans, features incurrence financial covenants or "cov-lite" provisions. These covenants differ from traditional loans' maintenance covenants, as they preserve equity control rights but impose specific restrictions on the borrower after crossing the covenant threshold. Contrary to the prevailing belief that incurrence covenants offer limited protection for creditors, our research reveals a significant and sudden decline in investment upon triggering these covenants. This evidence highlights a novel propagation mechanism for economic shocks, wherein contractual restrictions play a crucial role in the highly-leveraged corporate sector, becoming binding well before default or bankruptcy occurs.

Keywords: high-yield debt; corporate debt; covenants; incurrence covenants; cov-lite; amplification mechanisms; contracts; contingent contracting (search for similar items in EconPapers)
JEL-codes: G21 G31 G32 G33 (search for similar items in EconPapers)
Pages: 70
Date: 2023-08-22
New Economics Papers: this item is included in nep-cfn
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Related works:
Working Paper: High-Yield Debt Covenants and Their Real Effects (2022)
Working Paper: High-Yield Debt Covenants and Their Real Effects (2022)
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Persistent link: https://EconPapers.repec.org/RePEc:fip:feddwp:96606

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DOI: 10.24149/wp2311

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