Debt Heterogeneity and Covenants

66 Pages Posted: 25 Jul 2013 Last revised: 13 Dec 2018

See all articles by Yun Lou

Yun Lou

Singapore Management University - School of Accountancy

Clemens A. Otto

Singapore Management University - Lee Kong Chian School of Business

Date Written: May 3, 2018

Abstract

Coordination failure among owners of heterogeneous debt types increases distress costs. Covenants reduce expected distress costs by lowering the probability of liquidity shortages, increasing liquidation values, and incentivizing creditor monitoring. We predict and find that new debt contracts include more covenants when borrowers' existing debt structures are more heterogeneous. Our findings suggest that covenants are not only used to address creditor-shareholder conflicts but also to reduce the expected costs of coordination failure among creditors. Further, our results indicate a dynamic component missing from static debt structure models: Debt heterogeneity entails additional covenants (i.e., constraints) when raising future debt.

Keywords: Debt Heterogeneity, Debt Covenants, Creditor Conflicts, Coordination Failure

JEL Classification: G32

Suggested Citation

Lou, Yun and Otto, Clemens A., Debt Heterogeneity and Covenants (May 3, 2018). Paris December 2014 Finance Meeting EUROFIDAI - AFFI Paper, HEC Paris Research Paper No. FIN-2014-1033, Singapore Management University School of Accountancy Research Series Vol. 6, No. 3 Paper No 2018-83, Available at SSRN: https://ssrn.com/abstract=2297804 or http://dx.doi.org/10.2139/ssrn.2297804

Yun Lou

Singapore Management University - School of Accountancy ( email )

60 Stamford Road
Singapore 178900
Singapore

Clemens A. Otto (Contact Author)

Singapore Management University - Lee Kong Chian School of Business ( email )

469 Bukit Timah Road
Singapore 912409
Singapore

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