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Covenant violations and dynamic loan contracting

Felix Freudenberg, Bjorn Imbierowicz (), Anthony Saunders and Sascha Steffen

Journal of Corporate Finance, 2017, vol. 45, issue C, 540-565

Abstract: This paper examines the dynamic allocation of control rights in private debt contracts of firms. We show that a covenant violation in the prior loan contract implies a stigma for borrowers which results in stricter loan contract terms in subsequent new loan contracts. Our analyses reject potentially other explanations such as firm characteristics or agency problems between the lender and firm management, shareholders or public debtholders. After covenant violations in the prior contract, new loans have on average 18bps higher spreads and include more of those covenant types which also have been violated in the prior contract, with tighter thresholds.

Keywords: Control rights; Covenant violation; Dynamic loan contracting; Stigma (search for similar items in EconPapers)
JEL-codes: G21 G32 L14 (search for similar items in EconPapers)
Date: 2017
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Handle: RePEc:eee:corfin:v:45:y:2017:i:c:p:540-565