How Do Debt Contracts Allocate Control Over Unforeseen Investment Decisions?
54 Pages Posted: 23 May 2018 Last revised: 9 Jul 2019
Date Written: July 5, 2019
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: Suggested Citation