62 Pages Posted: 25 Jul 2013 Last revised: 30 Sep 2016
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: 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: https://ssrn.com/abstract=2297804 or http://dx.doi.org/10.2139/ssrn.2297804