Private Lenders’ Use of Analyst Earnings Forecasts When Establishing Debt Covenant Thresholds

55 Pages Posted: 13 Feb 2018

See all articles by Andrew C. Call

Andrew C. Call

Arizona State University (ASU) - School of Accountancy

John Donovan

University of Notre Dame - Department of Accountancy

Jared N. Jennings

Washington University in St. Louis

Date Written: January 2018

Abstract

We examine whether lenders use analyst forecasts of the borrowing firm’s earnings when establishing covenant thresholds in private debt contracts. We find greater proximity between the analysts’ consensus earnings forecast and the future earnings performance required by the contract among borrowers whose analysts have historically issued accurate earnings forecasts, consistent with our hypothesis that lenders use analyst earnings forecasts when establishing debt covenant thresholds. These results are robust to firm and year fixed effects as well as an instrumental variable approach that addresses potential correlated omitted variables. We also find that the likelihood that the borrower violates a debt covenant following a decline in creditworthiness is increasing in the extent to which the debt covenant threshold is set closer to analyst expectations, suggesting that lenders’ use of analyst research increases the effectiveness of debt covenants in transferring contingent control rights following declines in creditworthiness. Our results provide new evidence on the role of sell-side analysts in debt contracting and inform the literature on the information used by lenders when establishing debt covenant thresholds.

Keywords: Analysts, earnings forecasts, debt covenants

JEL Classification: M40, M41, G20, G21

Suggested Citation

Call, Andrew C. and Donovan, John and Jennings, Jared N., Private Lenders’ Use of Analyst Earnings Forecasts When Establishing Debt Covenant Thresholds (January 2018). Available at SSRN: https://ssrn.com/abstract=3119889 or http://dx.doi.org/10.2139/ssrn.3119889

Andrew C. Call (Contact Author)

Arizona State University (ASU) - School of Accountancy ( email )

Tempe, AZ 85287
United States

John Donovan

University of Notre Dame - Department of Accountancy ( email )

Mendoza College of Business
Notre Dame, IN 46556-5646
United States

Jared N. Jennings

Washington University in St. Louis ( email )

One Brookings Drive
Campus Box 1208
Saint Louis, MO MO 63130-4899
United States

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