Hedge Commitments and Agency Costs of Debt: Evidence from Interest Rate Protection Covenants and Accounting Conservatism

45 Pages Posted: 31 Aug 2009 Last revised: 4 Jul 2011

See all articles by Anne Beatty

Anne Beatty

Ohio State University (OSU) - Department of Accounting & Management Information Systems

Reining Petacchi

Georgetown University - Department of Accounting and Business Law

Haiwen Zhang

University of Minnesota

Date Written: May 20, 2011

Abstract

We provide large sample evidence that credible hedge commitments reduce the agency costs of debt and that accounting conservatism enhances hedge commitments. We examine 2,338 bank loans entered into by 263 mandatory derivative users that are contractually obligated by interest rate protection covenants, 709 voluntary derivative users, and 1,366 non-users. We show that loan contracts are more likely to include interest rate protection covenants when borrowers are less likely to maintain the hedge position once the financing is completed. We find that borrowers who credibly commit to hedge using the covenants significantly reduce their interest rates. While we do not find an average interest savings for voluntary derivative users, we do find a reduction in their loan rates when they practice conservative financial reporting. Our results suggest that accounting conservatism helps borrowers resolve shareholder-creditor conflicts by committing to maintain their hedge positions after completing debt financing.

Keywords: Interest rate risk, Hedge commitment

JEL Classification: D82, G10, G21, G24

Suggested Citation

Beatty, Anne L. and Petacchi, Reining and Zhang, Haiwen, Hedge Commitments and Agency Costs of Debt: Evidence from Interest Rate Protection Covenants and Accounting Conservatism (May 20, 2011). Available at SSRN: https://ssrn.com/abstract=1463001 or http://dx.doi.org/10.2139/ssrn.1463001

Anne L. Beatty

Ohio State University (OSU) - Department of Accounting & Management Information Systems ( email )

2100 Neil Avenue
Columbus, OH 43210
United States

Reining Petacchi

Georgetown University - Department of Accounting and Business Law ( email )

McDonough School of Business
Washington, DC 20057
United States

Haiwen Zhang (Contact Author)

University of Minnesota ( email )

3-122 Carlson School of Management
321-19th Avenue South
Minneapolis, MN 55455
United States

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