How Does Financing Impact Investment? The Role of Debt Covenants
Georgia Institute of Technology - Scheller College of Business
Michael R. Roberts
The Wharton School - University of Pennsylvania; National Bureau of Economic Research (NBER)
August 2, 2007
AFA 2007 Chicago Meetings Paper
We identify a specific channel (debt covenants) and the corresponding mechanism (transfer of control rights) through which financing frictions impact corporate investment. Using a regression discontinuity design, we show that capital investment declines sharply following a financial covenant violation, when creditors use the threat of accelerating the loan to intervene in management. Further, the reduction in investment is concentrated in situations where agency and information problems are relatively more severe, highlighting how the state contingent allocation of control rights can help mitigate investment distortions arising from financing frictions.
Number of Pages in PDF File: 61
Keywords: Investment, Covenant, Debt, Contracts, Renegotiation, Default, Control Rights
JEL Classification: G31, G33, G21, G32
Date posted: November 26, 2005
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