Financial Shocks and Corporate Investment Activity: The Role of Financial Covenants

46 Pages Posted: 5 Dec 2017 Last revised: 4 May 2018

See all articles by Hans Bonde Christensen

Hans Bonde Christensen

University of Chicago - Booth School of Business

Daniele Macciocchi

University of Utah - David Eccles School of Business

Valeri V. Nikolaev

University of Chicago Booth School of Business

Date Written: March 1, 2018

Abstract

We examine whether shocks to credit institutions affect the choice among accounting-based covenants in private debt contracts and whether this effect represents a channel through which shocks to lenders affect corporate investment. We exploit plausibly exogenous variation in the payment defaults experienced by lenders outside the borrower’s region and industry. We find that financial institutions respond to payment default shocks by shifting the composition of financial covenants towards performance-based covenants (away from capital-based covenants) in newly signed credit agreements. In turn, the increased reliance on performance covenants constrains borrowers’ future investments, particularly among relationship-based borrowers. We also find that lender-specific shocks after a contract is in place affect investments, and that this effect varies depending on the composition of the covenants in place. Overall, our results are consistent with financial covenants being a channel through which idiosyncratic shocks to lenders propagate to the real sector.

Keywords: Covenants, debt contracting, financial market frictions

JEL Classification: M4, G32

Suggested Citation

Christensen, Hans Bonde and Macciocchi, Daniele and Nikolaev, Valeri V., Financial Shocks and Corporate Investment Activity: The Role of Financial Covenants (March 1, 2018). 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 Utah - David Eccles School of Business ( email )

1645 E Campus Center Dr
Salt Lake City, UT 84112-9303
United States

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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