Contractual Complexity in Debt Agreements: The Case of EBITDA

55 Pages Posted: 26 Sep 2019 Last revised: 13 Sep 2022

See all articles by Adam B. Badawi

Adam B. Badawi

University of California, Berkeley - School of Law

Scott Dyreng

Duke University - Accounting

Elisabeth de Fontenay

Duke University School of Law

Robert Hills

Pennsylvania State University

Date Written: September 8, 2022

Abstract

We document significant variation across syndicated loans in the number of accounting addbacks in the contractual definition of EBITDA. We show addbacks are increasing over time and are associated with tighter financial covenant thresholds but fewer violations. Market responses to covenant violations are more negative when contractual EBITDA contains more addbacks. We also find that addbacks are positively (negatively) related to accrual (cash flow) volatility, suggesting accruals may be less informative about borrowers’ underlying ability to meet their obligations. Although, our findings suggest addbacks may enhance the informativeness of covenant realizations by generating fewer false positives violations (covenant violations where the borrower’s financial performance has not actually deteriorated), we also find addbacks are associated with collateral requirements and high loan spreads, suggesting addbacks may also produce more false negatives (no violation of a covenant when the borrower’s economic performance has deteriorated).

Keywords: debt covenant, leverage, EBITDA, credit agreement, accruals, cash flows

JEL Classification: G21, G23, G32, K12, K22, M41

Suggested Citation

Badawi, Adam B. and Dyreng, Scott and de Fontenay, Elisabeth and Hills, Robert, Contractual Complexity in Debt Agreements: The Case of EBITDA (September 8, 2022). Duke Law School Public Law & Legal Theory Series No. 2019-67, Available at SSRN: https://ssrn.com/abstract=3455497 or http://dx.doi.org/10.2139/ssrn.3455497

Adam B. Badawi

University of California, Berkeley - School of Law ( email )

215 Law Building
Berkeley, CA 94720-7200
United States

Scott Dyreng

Duke University - Accounting ( email )

Box 90120, Fuqua School of Business
Durham, NC 27708-0120
United States

Elisabeth De Fontenay (Contact Author)

Duke University School of Law ( email )

210 Science Drive
Box 90362
Durham, NC 27708
United States

Robert Hills

Pennsylvania State University ( email )

University Park, PA 16802-3306
United States

HOME PAGE: http://https://directory.smeal.psu.edu/rwh5494

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