Bank Relationship, Covenant Enforcement, and Creditor Control
67 Pages Posted: 26 Nov 2019
Date Written: October 2019
This paper investigates the effect of banking relationship on the likelihood of lenders’ enforcement of loan covenant violations. We find that if lenders have a long-run relationship with borrowers, these lenders enforce material covenant violations at a substantially lower rate when borrowers breach financial covenants. Moreover, borrowers with such relationships are less likely to experience raises in loan interest rates and a deterioration of subsequent financing and investment activities when they fail to fulfill their financial covenants. Further evidence shows that the mitigation of information asymmetry along the lending relationship is the driving force of the empirical findings.
Keywords: Bank Relationship, Covenant Violation, Loan Renegotiation
JEL Classification: G21, G32
Suggested Citation: Suggested Citation