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Bond covenants, bankruptcy risk, and the cost of debt

Sattar A. Mansi, Yaxuan Qi and John K. Wald

Journal of Corporate Finance, 2021, vol. 66, issue C

Abstract: Are all covenants equally effective at reducing the bondholder-shareholder conflict? Examining the most frequently used bond covenants, we document that four out of 24 restrictions are associated with significantly higher bankruptcy risk. The use of these Default Indicating covenants can be partly explained by faulty contract design, greater recovery in bankruptcy, or within-creditor conflicts. Firms that use In-House Counsel to help structure their bond issue and those that use Big 4 Auditors are also less likely to include Default Indicating covenants in their bonds. Further tests show that the use of these Default Indicating covenants is associated with higher bond and CDS spreads. Overall, the results help explain the prior evidence on the relation between covenant use and the cost of debt.

Keywords: Survival analysis; Bond covenants; Bankruptcy risk; Cost of debt (search for similar items in EconPapers)
JEL-codes: G12 G33 G34 (search for similar items in EconPapers)
Date: 2021
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Citations: View citations in EconPapers (6)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:corfin:v:66:y:2021:i:c:s0929119920302431

DOI: 10.1016/j.jcorpfin.2020.101799

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