Interrelation Among Events of Default
Messod Daniel Beneish
Indiana University Bloomington - Department of Accounting
Temple University - Department of Accounting
This paper contrasts technical default, debt service default and bankruptcy, and establishes that the valuation effects of their announcements are significant and increasingly severe. We show the events are interrelated. That is, technical default increases the likelihood of future debt service default and bankruptcy, and bankruptcy is more likely following debt service default. Further, we show that technical default is a timely warning of further distress insofar as adverse stock price effects of debt service default are mitigated if preceded by technical default.We also evaluate explanations of how debt service default and bankruptcy occur without firms first reporting technical default. We find that it is not because debt covenants are written with too much slack. While disclosure rules allow discretion in reporting technical default, our evidence suggests that non-reporting of covenant defaults occurs only in cases where the potential default is immaterial. We conclude that covenants do not always provide warnings of future difficulties.
JEL Classification: G32, G33, M40working papers series
Date posted: April 16, 1998
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