Uncertainty and debt covenants

Peter R. Demerjian ()
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Peter R. Demerjian: University of Washington

Review of Accounting Studies, 2017, vol. 22, issue 3, No 5, 1156-1197

Abstract: Abstract I examine the use of financial covenants when contracting for debt under uncertainty. Uncertainty, in the context of this study, is a lack of information about future economic events and their consequences for the borrower’s creditworthiness. I examine the implications of ex ante uncertainty that is resolved by information received following loan initiation but prior to maturity. I argue that financial covenants, by transferring control rights ex post, provide a trigger for creditor-initiated renegotiation when the borrower is revealed to be of low credit quality. Using a large sample of private loans, I predict and find that financial covenant intensity is associated with greater uncertainty. I also revisit the agency-based explanation for covenant use and find that this uncertainty explanation is robust to various controls for agency conflicts.

Keywords: Debt covenants; Uncertainty; Debt contracting; Agency theory (search for similar items in EconPapers)
JEL-codes: D86 G30 G32 M41 (search for similar items in EconPapers)
Date: 2017
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Citations: View citations in EconPapers (20)

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DOI: 10.1007/s11142-017-9409-z

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