Financial Covenants, Firm Financing, and Investment

Konrad Adler
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Konrad Adler: University of St. Gallen - School of Finance; Swiss Finance Institute

No 25-70, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: This paper studies how financial covenants, provisions included in most loan contracts, influence firm investment. I develop a structural model incorporating covenants and find that they allow for 4.7% higher aggregate investment relative to a no-covenants baseline. While covenants are beneficial overall, the model also reveals costs faced by firms attempting to avoid covenant violations. In two applications of the model, I find that, first, the transmission of aggregate shocks to firm financing crucially depends on firms' efforts to avoid covenant violations. Second, the model shows that earnings-based covenants allow for higher investment in industries with low asset pledgeability but offer no advantage when assets can be easily pledged.

Keywords: Financial Constraints; Covenants; Investment; Heterogeneous Firms (search for similar items in EconPapers)
JEL-codes: E44 G31 G32 (search for similar items in EconPapers)
Pages: 72 pages
Date: 2025-08
New Economics Papers: this item is included in nep-fdg
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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp2570

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