Contractual Complexity in Debt Agreements: The Case of EBITDA

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