Do Creditor Rights Increase Employment Risk? Evidence from Loan Covenants

54 Pages Posted: 31 Aug 2014 Last revised: 25 Mar 2015

See all articles by Antonio Falato

Antonio Falato

Board of Governors of the Federal Reserve System

Nellie Liang

Brookings Institution

Multiple version iconThere are 2 versions of this paper

Date Written: December 1, 2014


Financial contracts that mitigate incentive conflicts between firms and their creditors have a large impact on employees. Using a regression discontinuity design, we provide evidence that there are sharp and substantial employment cuts following loan covenant violations, when creditors gain rights to accelerate, restructure, or terminate a loan. The employment cuts following violations are larger at firms with higher financing frictions and when employees have weaker bargaining power. The cuts are also much larger in industry and macroeconomic downturns, when employees have fewer alternative job opportunities. In addition, union elections that create new labor bargaining units lead to higher loan spreads, consistent with creditors requiring compensation when employees have more bargaining power. Our analysis identifies a specific channel -- loan covenants -- through which financing frictions impact employment and offers direct evidence that binding financial contracts are an amplification mechanism of economic downturns.

Keywords: real effects of financing, labor and finance, financial frictions over the business cycle

JEL Classification: G30

Suggested Citation

Falato, Antonio and Liang, Nellie, Do Creditor Rights Increase Employment Risk? Evidence from Loan Covenants (December 1, 2014). Journal of Finance, Forthcoming. Available at SSRN: or

Antonio Falato (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th & C. St., N.W.
Washington, DC 20551
United States

Nellie Liang

Brookings Institution

1775 Massachusetts Ave, NW
Washington, DC 20036
United States

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