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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 Roberts/Sufi Roberts/Sufi Roberts/Sufi Roberts/Sufi • 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