How Do Debt Contracts Allocate Control Over Unforeseen Investment Decisions?

54 Pages Posted: 23 May 2018 Last revised: 9 Jul 2019

See all articles by Daniel Saavedra

Daniel Saavedra

UCLA Anderson School of Management

Date Written: July 5, 2019

Abstract

I examine how debt contracts allocate control over unforeseen investment decisions. Consistent with theoretical arguments, I find that debt contracts more likely to face unforeseen investment decisions (1) rely relatively more on performance or income statement-based covenants than on balance sheet-based covenants, and (2) provide more flexibility over time in capital expenditure restrictions (e.g., by making investments contingent on the borrower’s EBTIDA or by allowing the borrower to carryforward unused capital expenditure amounts). Furthermore, consistent with parties designing contracts efficiently, I find a roughly similar fit for regressions of investment on Tobin’s q across covenant packages.

Keywords: Investments, Loan Maturity, Covenants, Security Design, Bank Loans

JEL Classification: G32, G21, C78, L14

Suggested Citation

Saavedra, Daniel, How Do Debt Contracts Allocate Control Over Unforeseen Investment Decisions? (July 5, 2019). Available at SSRN: https://ssrn.com/abstract=3179705 or http://dx.doi.org/10.2139/ssrn.3179705

Daniel Saavedra (Contact Author)

UCLA Anderson School of Management ( email )

Los Angeles, CA
United States

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