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How Does Financing Impact Investment? The Role of Debt Covenants

61 Pages Posted: 26 Nov 2005  

Sudheer Chava

Georgia Institute of Technology - Scheller College of Business

Michael R. Roberts

The Wharton School - University of Pennsylvania; National Bureau of Economic Research (NBER)

Date Written: August 2, 2007

Abstract

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.

Keywords: Investment, Covenant, Debt, Contracts, Renegotiation, Default, Control Rights

JEL Classification: G31, G33, G21, G32

Suggested Citation

Chava, Sudheer and Roberts, Michael R., How Does Financing Impact Investment? The Role of Debt Covenants (August 2, 2007). AFA 2007 Chicago Meetings Paper. Available at SSRN: https://ssrn.com/abstract=854324 or http://dx.doi.org/10.2139/ssrn.854324

Sudheer Chava

Georgia Institute of Technology - Scheller College of Business ( email )

800 West Peachtree St.
Atlanta, GA 30308
United States

HOME PAGE: http://www.prism.gatech.edu/~schava6/

Michael R. Roberts (Contact Author)

The Wharton School - University of Pennsylvania; National Bureau of Economic Research (NBER) ( email )

3620 Locust Walk, #2320
Philadelphia, PA 19104-6365
United States
(215) 573-9780 (Phone)

HOME PAGE: http://finance.wharton.upenn.edu/~mrrobert/

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