Why Do Loans Contain Covenants? Evidence from Lending Relationships

65 Pages Posted: 18 Mar 2012 Last revised: 3 May 2016

See all articles by Robert Prilmeier

Robert Prilmeier

Tulane University - A.B. Freeman School of Business

Date Written: April 28, 2016

Abstract

Despite the importance of banks' role as delegated monitors, little is known about how non-price terms of loan contracts are structured to optimize information production in a lending relationship. Using a large sample of corporate loans, this paper examines the effect of relationship lending on covenant choice. Consistent with information asymmetry theories, covenant tightness is relaxed over the duration of a relationship, especially for opaque borrowers. In contrast, the effect of lending relationship intensity on the number of covenants included in a loan follows an inverted U shape. I discuss potential explanations for this finding.

Keywords: Relationships, Banking, Covenants, Information asymmetries, Monitoring incentives

JEL Classification: D82, G21, G30, G32, L14

Suggested Citation

Prilmeier, Robert, Why Do Loans Contain Covenants? Evidence from Lending Relationships (April 28, 2016). Journal of Financial Economics (JFE), Forthcoming, Available at SSRN: https://ssrn.com/abstract=2023791 or http://dx.doi.org/10.2139/ssrn.2023791

Robert Prilmeier (Contact Author)

Tulane University - A.B. Freeman School of Business ( email )

7 McAlister Drive
New Orleans, LA 70118
United States

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