Spillovers From Creditor Control

Abstract

A loan covenant violation is informative to parties outside of the lender-firm pair that agreed to the covenant term. Using a hierarchical matching estimator to measure causal spillover effects from covenant violation, I find that covenant violators have more severe reductions in financing and investment when a greater fraction of rival firms are also in violation of a covenant. Consistent with the ex post utilization of peer violation rates to inform the renegotiation decision, I find that, ex ante, creditors use stricter covenants on new loans when uncertainty about industry risk is high and a shorter effective maturity is desirable. I also find that causal spillover effects to non-violators are beneficial in that non-violators capture market share relative to violators in response to peer firm violation.

Keywords: SUTVA, hierarchical matching, loan covenants, spillover effects

JEL Classification: G31, G32, G21