Abstract

http://ssrn.com/abstract=1919715
 
 

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Debt Covenants and Capital Structure: Evidence from
an Exogenous Shock to Debt Capacity


Moshe Cohen


Columbia Business School

Sharon P. Katz


Columbia Business School - Accounting, Business Law & Taxation

Gil Sadka


Columbia Business School - Accounting, Business Law & Taxation

July 9, 2012

Western Finance Association 2012 Annual Meeting

Abstract:     
This paper empirically examines how debt covenants impact the capital structure choices of firms, by utilizing an exogenous accounting based shock to the distance to covenant violation. We find that, on average, the shock to debt capacity had a positive impact on the debt choices of all treated firms, but the response was strongest by firms that were close to violating or in violation of the affected covenants, and that were otherwise financially unconstrained. Our findings suggest that debt covenants are a key component of the capital structure trade-off that influences debt choices well before they are triggered. We proceed to examine how the additional debt affected firms' corporate financial behavior and find that it did not result in an increase in investments or cash holdings, but rather was associated with lower profitability and a lower likelihood to enter default or bankruptcy. Some firms even maintained or increased their dividend payouts.

Number of Pages in PDF File: 55

Keywords: Debt, covenants, financial constraints, leverage, investments, default

JEL Classification: G01, G30, G31, G33, M21, M41

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Date posted: August 31, 2011 ; Last revised: July 12, 2012

Suggested Citation

Cohen, Moshe and Katz, Sharon P. and Sadka, Gil, Debt Covenants and Capital Structure: Evidence from an Exogenous Shock to Debt Capacity (July 9, 2012). Western Finance Association 2012 Annual Meeting. Available at SSRN: http://ssrn.com/abstract=1919715 or http://dx.doi.org/10.2139/ssrn.1919715

Contact Information

Moshe Cohen
Columbia Business School ( email )
3022 Broadway
New York, NY 10027
United States
(212) 854-1486 (Phone)
Sharon P. Katz (Contact Author)
Columbia Business School - Accounting, Business Law & Taxation ( email )
3022 Broadway
New York, NY 10027
United States

Gil Sadka
Columbia Business School - Accounting, Business Law & Taxation ( email )
3022 Broadway
613 Uris Hall
New York, NY 10027
United States
212-854-5391 (Phone)

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