Risk Management, Agency Costs, and Lending Covenants
68 Pages Posted: 15 Jan 2021 Last revised: 8 Sep 2021
Date Written: September 7, 2020
We document the importance of loan covenants to observed hedging outcomes, by studying lending agreements and derivative positions of U.S. oil and gas producers. The emergence of fracking technology was accompanied by sharp increases in capital spending and borrowing. The contracts involved often include covenants specifying hedging policies, and more frequently for firms with higher expected costs of default. Firms with contractual hedging commitments have lower borrowing costs and perform better during the COVID-19 pandemic, even after controlling for hedging levels. The results imply that understanding firm’s hedging outcomes requires consideration of binding lending covenants employed to mitigate agency conflicts.
Keywords: hedging, risk management, debt, covenants, credit boom, fracking
JEL Classification: G30, G32, G21
Suggested Citation: Suggested Citation