Download Debt Covenants

Roberts and Sufi (2009)
• Here the concern is financial policies.
• To what extent do incentive conflicts and creditor rights
influence financial policies?
• How do incentive conflicts and creditor rights influence
financial policies?
• As in the last paper the focus is on violations.
– Violations are frequent but rarely lead to payment default or
bankruptcy. They are thus a potentially important concern for
firms outside of distress. The focus here is ex post, my interest
would be ex ante.
– Violation allows the debt to be accelerated. More commonly
lenders reduce the size of the credit facility, increase the interest
rate (spread) and require additional collateral. Think of a
standard bargaining game with outside options.
Roberts/Sufi
• Summary Statistics
– 90% of credit agreements contain restrictions on the borrowers
total debt (level or interest payments)
– Over ¼ of firms experience a violation
• For firms with an average leverage ratio of at least 5% the percent of
violators reaches 30%
• Violations cluster, a firm is 20 percentage points more likely to violate
a covenant if it has done so in the previous year
– Small firms significantly more likely to violate than large firms
– 1 yr probability of violating a covenant negatively related to
credit rating
• Except for firms rated CCC or worse, probability of violating a
covenant significantly larger than probability of defaulting on a
payment
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• Empirical Strategy
– Primary empirical concern is that firm changes around
violation would imply the policy change in the
absence of the violation
– Goal is to show that managers would not have altered
the financial policies in the same way without the
violation
– Focus only on discontinuous changes in financial
policy occurring at the covenant threshold
– The estimated impact of the indicator for violation is
then identified as long a managerial preferences are
not discontinuous exactly at the covenant threshold
Roberts/Sufi
• Net Debt Issuance Regressions
– After controlling for usual suspects in capital structure,
initial covenant violations associated with a significant
drop in debt issuance – 50+ basis points relative to lagged
assets
• Estimating using first differences provides similar results
• “Subsequent” violations do not lead to significant changes in
policy
• Reductions in net debt issuance is larger for firms with higher
leverage
• Firms with higher market-to-book ratios (growth opportunities or
equity valuation) see less of a reduction
• Firms with rated debt see a much much smaller reduction in debt
issuance
• Points to fact that the lender’s bargaining power helps determine
the extent to which financial policy is affected
Roberts/Sufi
• Long run effects
– Net debt issuance drops sharply and remains
significantly lower for two years after violation
• Economic magnitudes
– Estimated effects moves a firm from the 65th
percentile to the 40th percentile of the with-in firm
distribution of debt issuance
– Short run impact of violation has larger effect that
two standard deviation change in common
explanatory variables for leverage