Contracting Costs, Covenant-Lite Lending and Reputational Capital

53 Pages Posted: 7 Jan 2021 Last revised: 23 Mar 2023

See all articles by Dominique C. Badoer

Dominique C. Badoer

University of Illinois at Chicago - Department of Finance

Mustafa Emin

Tulane University

Christopher M. James

University of Florida - Department of Finance, Insurance and Real Estate

Date Written: March 17, 2023

Abstract

Using a large sample of leveraged loans, we provide evidence that, despite having fewer creditor control rights, covenant-lite loans have similar recovery rates and significantly lower spreads than loans with maintenance covenants. We find that the propensity to borrow covenant-lite is related to various proxies for the reputational capital of a borrowing firm’s private equity sponsor. We construct a simple model to illustrate the relationship between reputational capital, covenants, and loan spreads in the leveraged loan market. Our model illustrates how reputational capital can substitute for covenants in mitigating agency costs of debt, leading to lower loan spreads for covenant-lite loans.

Keywords: Cov-Lite Loans, Institutional Loans, Private Equity Firms, Reputational Contracting

JEL Classification: G21, G23, G29, G33

Suggested Citation

Badoer, Dominique C. and Emin, Mustafa and James, Christopher M., Contracting Costs, Covenant-Lite Lending and Reputational Capital (March 17, 2023). Available at SSRN: https://ssrn.com/abstract=3536458 or http://dx.doi.org/10.2139/ssrn.3536458

Dominique C. Badoer (Contact Author)

University of Illinois at Chicago - Department of Finance ( email )

2431 University Hall (UH)
601 S. Morgan Street
Chicago, IL 60607-7124
United States

Mustafa Emin

Tulane University ( email )

1440 Canal St.
NEW ORLEANS, LA 70112

Christopher M. James

University of Florida - Department of Finance, Insurance and Real Estate ( email )

P.O. Box 117168
Gainesville, FL 32611-7168
United States
352-392-3486 (Phone)
352-392-0301 (Fax)

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