Do Creditor Rights Increase Employment Risk? Evidence from Debt Covenants

52 Pages Posted: 18 Dec 2012

See all articles by Antonio Falato

Antonio Falato

Board of Governors of the Federal Reserve System

Nellie Liang

Brookings Institution

Multiple version iconThere are 2 versions of this paper

Date Written: April 1, 2012


This paper studies whether financial contracts exacerbate or mitigate agency conflicts among stakeholders. We consider a specific contractual provision, debt covenants, and examine how, by allocating control rights between shareholders and debtholders, debt covenants affect the employment relationship. We analyze the role of covenants in both public (bonds) and private (loans) debt contracts. For public debt covenants, we estimate dynamic employment equations and find a significant negative effect of leverage on employment only for firms with relatively high covenant protection. For private debt covenants, we use a regression discontinuity design and document sizable job cuts following a covenant violation. Overall, these findings suggest that creditor rights increase employment risk. As such, they complement the recent literature on financial covenants by showing that covenants affect a broader set of operating decisions than previously recognized. Moreover, the results contribute to our understanding of the consequences of the allocation of control rights within the firm by identifying a specific risk-shifting channel from debtholders to employees.

Keywords: covenant violations, employment

JEL Classification: G30

Suggested Citation

Falato, Antonio and Liang, Nellie, Do Creditor Rights Increase Employment Risk? Evidence from Debt Covenants (April 1, 2012). FEDS Working Paper No. 2012-42. Available at SSRN: or

Antonio Falato (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th & C. St., N.W.
Washington, DC 20551
United States

Nellie Liang

Brookings Institution

1775 Massachusetts Ave, NW
Washington, DC 20036
United States

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