Covenant Amendment Fee and Value of Creditor Intervention after Covenant Violations

Abstract

State-contingent control rights allow creditors to intervene after borrowers’ negative performance. Identifying the value of ex-post creditor intervention remains an empirical challenge due to the unknown counterfactual outcomes and the lack of randomly assigned treatment. In this paper, we investigate this question through examining an important form of renegotiation outcomes following covenant violations– the payment of amendment fee, which has been largely overlooked in the previous literature. Exploiting a hand-collected novel data on covenant amendments in corporate loan contracts, we first document the prevalence of nontrivial amendment fee payment made by borrowers in violation of covenants in exchange for waivers of covenant violations. We find that the amendment fee payment following covenant violation exhibits clear exclusiveness with explicit creditor intervention– only 6.9% covenant violations are followed by both amendment fee payments and creditor intervention on firm policy. This exclusiveness of amendment fee payment and creditor intervention suggests a potential time consistency issue in corporate debt contracting– creditors cannot commit to intervening after borrowers’ negative performance once been offered a side-payment for not doing so. We then examine factors that may affect the occurrence and the size of amendment fee payment following covenant violations. These factors include borrower side factors, creditor side factors and aggregate economic conditions. Eventually, we exploit variations in creditors’ share in borrowers’ outstanding liability as a measure of creditors’ skin-in-the-game to extract exogenous variations in the treatment assignment following covenant violations– whether or not interventions are undertaken. Using this instrumental variable, we identify a significantly positive real value added by creditors taking explicit actions intervening the operation of borrowers in covenant violations.

Keywords: Renegotiation, Incomplete Contracts, Bank Loans, Corporate Financing, Covenants

JEL Classification: G32, G21, C78, L14, C80