Losing Control? The Two-Decade Decline in Loan Covenant Violations

68 Pages Posted: 27 Nov 2018 Last revised: 17 Sep 2023

See all articles by Thomas P. Griffin

Thomas P. Griffin

Villanova University - Department of Finance & Real Estate

Greg Nini

Drexel University - Department of Finance

David C. Smith

University of Virginia - McIntire School of Commerce

Date Written: September 15, 2023

Abstract

The annual proportion of U.S. public firms that reported a financial covenant violation fell roughly 70% between 1997 and 2019. To understand this trend, we develop an estimable model of covenant design that depends on the ability to discriminate between distressed and non-distressed borrowers and the relative costs associated with screening incorrectly. We find the drop in violations is best explained by an increased willingness to forego early detection of distressed borrowers in exchange for fewer inconsequential violations, which we attribute mostly to a shift in the composition of public firms and partly to heightened investor sentiment during the 2010s.

Keywords: financial contracting, control rights, financial covenants, credit agreements

JEL Classification: G21, G23, G32, G34

Suggested Citation

Griffin, Thomas and Nini, Gregory and Smith, David Carl, Losing Control? The Two-Decade Decline in Loan Covenant Violations (September 15, 2023). Available at SSRN: https://ssrn.com/abstract=3277570 or http://dx.doi.org/10.2139/ssrn.3277570

Thomas Griffin

Villanova University - Department of Finance & Real Estate ( email )

United States

HOME PAGE: http://www.thomaspgriffin.com

Gregory Nini

Drexel University - Department of Finance ( email )

LeBow College of Business
Philadelphia, PA 19104
United States

David Carl Smith (Contact Author)

University of Virginia - McIntire School of Commerce ( email )

P.O. Box 400173
Charlottesville, VA 22904-4173
United States

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