Private Equity and Debt Contract Enforcement: Evidence from Covenant Violations

Sharjil Haque and Anya V. Kleymenova
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Anya V. Kleymenova: https://www.federalreserve.gov/econres/anya-v-kleymenova.htm

No 2023-018, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

Abstract: We document the importance of a financial sponsor when a borrower violates a covenant, providing creditors the opportunity to enforce debt contracts. We identify private-equity (PE) sponsored borrowers in the Shared National Credit Program (SNC) data and find PE-sponsored borrowers violate covenants more often than comparable non-PE borrowers. Yet, compared to non-PE, PE-backed borrowers experience smaller reductions in credit commitment upon violation, suggesting lenders are lenient with PE sponsors. Moreover, this leniency is stronger among financially healthier lenders. We show that our results are consistent with a repeated-deals mechanism, as lenders frequently interact with financial sponsors and choose to preserve relationship rent. Consistent with this mechanism, we find little evidence that PE-sponsored loans eventually underperform relative to non-PE-sponsored ones following covenant violations. Our findings have important implications for understanding heterogeneity in debt contract enforcement and credit constraints faced by distressed borrowers with financial sponsors.

Keywords: Private Equity Funds; Covenants; Debt Contract Enforcement; Bank Lending (search for similar items in EconPapers)
JEL-codes: G00 G10 G30 G32 G33 (search for similar items in EconPapers)
Pages: 69 p.
Date: 2023-04-11
New Economics Papers: this item is included in nep-ban and nep-cfn
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedgfe:2023-18

DOI: 10.17016/FEDS.2023.018

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