Gus De Franco
University of Toronto - Rotman School of Management
Florin P. Vasvari
London Business School
University of Toronto - Rotman School of Management; University of Toronto at Mississauga
Regina Wittenberg Moerman
University of Chicago - Booth School of Business
March 1, 2013
Chicago Booth Research Paper No. 13-61
Rotman School of Management Working Paper No. 2288723
This study examines the factors that explain the level of protection provided by covenant packages in public bond contracts. We employ a unique covenant dataset constructed by Moody’s that allows us to measure the restrictiveness of bond covenant packages beyond the bond covenant inclusion measures used in prior literature. We find that measures capturing information asymmetry about the borrower and bondholders’ bargaining power are associated with more restrictive covenants, but that the effect of these measures is relatively modest. In contrast, we find that the covenant restrictiveness of a bond is very sticky over time: it is primarily determined by the covenant restrictiveness of the borrower’s previous bond issues. We also find that covenant restrictiveness is affected by the restrictiveness of the covenant packages in previous bonds issued by industry peers, the previous bonds arranged by the firm’s underwriter and the previous bonds advised by the firm’s and underwriter’s legal counsels. The latter results are consistent with the idea of bond contract rigidity and “boilerplate” economics proposed by the corporate law literature.
Number of Pages in PDF File: 64working papers series
Date posted: July 4, 2013
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