Further Evidence on Consequences of Debt Covenant Violations
63 Pages Posted: 14 Apr 2013 Last revised: 23 Apr 2016
Date Written: April 21, 2016
We present new evidence on debt covenant violation (DCV) consequences that have not previously been examined in the literature. In particular, we show that a DCV triggers significant information asymmetry and uncertainty on the part of shareholders and auditors as reflected in higher bid-ask spreads, return volatility, and audit fees. Further, these consequences occur even when lender-imposed costs are relatively lower, consistent with the act of default itself triggering shareholder and auditor uncertainty. The results highlight costs to the firm of having bright-line rules in contracts, and add to an understanding of the consequences of DCVs.
Keywords: Debt covenant violations, Shareholder uncertainty, Information asymmetry, Audit fees
JEL Classification: M41, G3
Suggested Citation: Suggested Citation