High-Yield Debt Covenants and Their Real Effects

Falk Bräuning, Victoria Ivashina and Ali Ozdagli

No 22-5, Working Papers from Federal Reserve Bank of Boston

Abstract: High-yield debt, including leveraged loans, is characterized by incurrence financial covenants, or “cov-lite” provisions. Unlike, traditional, maintenance covenants, incurrence covenants preserve equity control rights but trigger pre-specified restrictions on the borrower’s actions once the covenant threshold is crossed. We show that restricted actions impose significant constraints on investments: Similar to the effects of the shift of control rights to creditors in traditional loans, the drop in investment under incurrence covenants is large and sudden. This evidence suggests a new shock amplification mechanism through contractual restrictions that are at play for a highly levered corporate sector long before default or bankruptcy.

Keywords: high-yield debt; corporate debt; covenants; incurrence covenants; cov-lite; amplification mechanisms; contracts; contingent contracting (search for similar items in EconPapers)
JEL-codes: G21 G31 G32 G33 (search for similar items in EconPapers)
Pages: 49
Date: 2022-03-01
New Economics Papers: this item is included in nep-cfn
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Citations: View citations in EconPapers (2)

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Related works:
Working Paper: High-Yield Debt Covenants and Their Real Effects (2023)
Working Paper: High-Yield Debt Covenants and Their Real Effects (2022)
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DOI: 10.29412/res.wp.2022.05

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