Bank Relationship and Contractual Flexibility: Evidence from Covenant Enforcement

67 Pages Posted: 26 Nov 2019 Last revised: 8 Apr 2022

See all articles by Yong Kyu Gam

Yong Kyu Gam

University College Dublin (UCD)

Chunbo Liu

Institute of Financial Studies, Southwestern University of Finance and Economics

Date Written: April 2, 2022

Abstract

This paper investigates how banks utilize soft information to provide contractual flexibility in loan covenant enforcement. We find that relationship lenders are significantly less likely to enforce material covenant violations when borrowers breach financial covenants. The mitigation of information asymmetry along relationship lending, rather than alternative explanations, is the underlying mechanism. In addition, covenant-breaching borrowers with such relationships are less likely to experience raises in loan interest rates, to reduce subsequent financing and investment activities, and to file for bankruptcy. Our findings imply that soft information accumulated during lending relationship is vital for banks to provide contractual flexibility.

Keywords: Contractual flexibility, Bank relationship, Covenant violation

JEL Classification: G21, G32

Suggested Citation

Gam, Yong Kyu and Liu, Chunbo, Bank Relationship and Contractual Flexibility: Evidence from Covenant Enforcement (April 2, 2022). Available at SSRN: https://ssrn.com/abstract=3486614 or http://dx.doi.org/10.2139/ssrn.3486614

Yong Kyu Gam (Contact Author)

University College Dublin (UCD) ( email )

Belfield
Belfield, Dublin 4 4
Ireland

Chunbo Liu

Institute of Financial Studies, Southwestern University of Finance and Economics ( email )

55 Guanghuacun Street
Qingyang area
Chengdu, Sichuan 610074
China

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
95
Abstract Views
572
rank
380,090
PlumX Metrics