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

53 Pages Posted: 5 Dec 2017 Last revised: 1 May 2019

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

Arthur Morris

New York University (NYU), Shanghai

Valeri V. Nikolaev

University of Chicago Booth School of Business

Date Written: April 29, 2019

Abstract

We examine whether economic shocks to credit institutions differentially affect the use and strictness of different accounting-based covenants in debt contracts, and whether these effects represent a channel through which shocks to lenders propagate to the real sector. To capture lender-specific shocks, we use variation in payment defaults experienced by lenders outside the borrower’s region and industry. We find that lenders respond to payment defaults by shifting towards performance-based covenants (and away from capital-based covenants), and by increasing the strictness of performance covenants. In turn, these changes in covenants constrain future investments among relationship borrowers. We also find that subsequent to contract initiation, lender-specific shocks affect corporate investment. Overall, our results suggest that credit-supply frictions influence the type and strictness of covenants in debt contracts, and that financial covenants represent a channel through which shocks to lenders are transmitted to the nonfinancial sector.

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 and Corporate Investment Activity: The Role of Financial Covenants (April 29, 2019). 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

Arthur Morris

New York University (NYU), Shanghai ( email )

1555 Century Ave
Shanghai, Shanghai 200122
China

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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