Contractual Complexity in Debt Agreements: The Case of EBITDA

Abstract

We document significant variation in the contractual definition of EBITDA across syndicated loans and develop a permissiveness score based on the number of adjustments included in EBITDA definitions. We show that permissiveness is associated with tighter covenants but fewer violations. Market responses to covenant violations are more negative when permissiveness is higher. We also find that permissiveness is positively (negatively) related to accrual (cash flow) volatility, suggesting accruals may be less informative about borrowers’ underlying ability to meet their obligations. Our findings suggest that permissiveness in EBITDA definitions enhances the informativeness of covenant realizations by refining EBITDA to better reflect the borrower’s true financial condition.

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

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