Further Evidence on Consequences of Debt Covenant Violations

63 Pages Posted: 14 Apr 2013 Last revised: 23 Apr 2016

Yu Gao

University of St Thomas, Opus College of Business

Mozaffar Khan

University of Minnesota - Twin Cities - Carlson School of Management

Liang Tan

George Washington University - Department of Accountancy

Date Written: April 21, 2016

Abstract

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

Gao, Yu and Khan, Mozaffar and Tan, Liang, Further Evidence on Consequences of Debt Covenant Violations (April 21, 2016). Available at SSRN: https://ssrn.com/abstract=2250750 or http://dx.doi.org/10.2139/ssrn.2250750

Yu Gao

University of St Thomas, Opus College of Business ( email )

1000 Lasalle Ave
Minneapolis, MN 55403
United States

Mozaffar Khan (Contact Author)

University of Minnesota - Twin Cities - Carlson School of Management ( email )

19th Avenue South
Minneapolis, MN 55455
United States

Liang Tan

George Washington University - Department of Accountancy ( email )

School of Business and Public Management
Washington, DC 20052
United States

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