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Debt Heterogeneity and Covenants

62 Pages Posted: 25 Jul 2013 Last revised: 3 Aug 2017

Yun Lou

Singapore Management University

Clemens A. Otto

Singapore Management University

Date Written: September 29, 2016


Coordination failure among the owners of heterogeneous debt types can increase expected distress costs. Covenants can help reduce these costs by lowering the probability of liquidity defaults. We show that loans are indeed subject to more covenants when the borrowers' debt structures are more heterogeneous. Our findings suggest that covenants are used to reduce not only creditor-shareholder conflicts but also the expected costs of coordination failure among creditors holding different types of debt. Further, our results indicate a dynamic component missing from static debt structure models: Debt heterogeneity leads to 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 (September 29, 2016). Paris December 2014 Finance Meeting EUROFIDAI - AFFI Paper; HEC Paris Research Paper No. FIN-2014-1033. Available at SSRN: or

Yun Lou

Singapore Management University ( email )

60 Stamford Road
Singapore 178900

Clemens A. Otto (Contact Author)

Singapore Management University ( email )

Li Ka Shing Library
70 Stamford Road
Singapore 178901, 178899

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