Financial Shocks to Lenders and the Composition of Financial Covenants

46 Pages Posted: 5 Dec 2017 Last revised: 13 Apr 2020

See all articles by Hans Bonde Christensen

Hans Bonde Christensen

University of Chicago - Booth School of Business

Daniele Macciocchi

University of Miami Herbert Business School

Arthur Morris

Hong Kong University of Science & Technology (HKUST) - Department of Accounting

Valeri V. Nikolaev

University of Chicago Booth School of Business

Date Written: November 29, 2017

Abstract

We show that financial shocks to lenders affect the composition of covenants in new debt contracts in a way that cannot be explained by borrower fundamentals. Using two distinct measures of lender-specific shocks — defaults in a lender’s corporate loan portfolio that occur outside the borrower’s region and industry, and non-corporate loan delinquencies — we show that lenders respond to financial shocks by increasing the use and strictness of performance-based and negative covenants, while reducing the use of capital covenants. We investigate two possible channels for these effects, specifically, the capital channel (lenders are concerned about capital depletion) and the learning channel (defaults carry information about lenders’ screening ability), and find evidence in support of both. Overall, our results indicate that lenders’ preferences influence the use of accounting information in debt contracts.

Keywords: covenants, debt contracting, financial market frictions

JEL Classification: M4, G32

Suggested Citation

Christensen, Hans Bonde and Macciocchi, Daniele and Morris, Arthur and Nikolaev, Valeri V., Financial Shocks to Lenders and the Composition of Financial Covenants (November 29, 2017). Available at SSRN: https://ssrn.com/abstract=3079996 or http://dx.doi.org/10.2139/ssrn.3079996

Hans Bonde Christensen

University of Chicago - Booth School of Business ( email )

5807 South Woodlawn Avenue
Chicago, IL 60637
United States

Daniele Macciocchi (Contact Author)

University of Miami Herbert Business School ( email )

P.O. Box 248126
Florida
Coral Gables, FL 33124
United States

Arthur Morris

Hong Kong University of Science & Technology (HKUST) - Department of Accounting ( email )

Clear Water Bay
Kowloon
Hong Kong

Valeri V. Nikolaev

University of Chicago Booth School of Business ( email )

5807 South Woodlawn Avenue
Chicago, IL 60637
United States

HOME PAGE: http://faculty.chicagobooth.edu/valeri.nikolaev/index.html

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