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Debt covenant design and creditor control rights: Evidence from the tightest covenant

Jing Wang

Journal of Corporate Finance, 2017, vol. 44, issue C, 331-352

Abstract: Within the same debt contract, some financial covenants are considerably more restrictive than others. I exploit this heterogeneity in covenant design and show that the design of the most restrictive covenant is systematically associated with covenant outcomes - compliance, violations, or renegotiations. Consistent with an alleviation of moral hazard problems, tighter capital expenditure restrictions (performance covenants) are more likely to facilitate ex post creditor control through covenant renegotiations (violations). By contrast, borrowers are more likely to comply with contracts with tighter capital covenants, suggesting that these covenants more effectively align shareholder-creditor interests ex ante to avoid adverse selection problems.

Keywords: Financial contracting; Incomplete contracts; Creditor rights; Asymmetric information; Agency problems (search for similar items in EconPapers)
JEL-codes: G32 G34 D82 (search for similar items in EconPapers)
Date: 2017
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DOI: 10.1016/j.jcorpfin.2017.04.004

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