Bond Covenants, Bankruptcy Risk, and the Cost of Debt

62 Pages Posted: 5 Jan 2021

See all articles by Sattar Mansi

Sattar Mansi

Virginia Polytechnic Institute & State University

Yaxuan Qi

City University of Hong Kong (CityU) - Department of Economics & Finance

John K. Wald

University of Texas at San Antonio

Date Written: November 23, 2020

Abstract

Are all covenants equally effective at reducing the bondholder-shareholder conflict? Examining the most frequently used bond covenants, we document that four out of 24 restrictions are associated with significantly higher bankruptcy risk. The use of these Default Indicating covenants can be partly explained by faulty contract design, greater recovery in bankruptcy, or within-creditor conflicts. Firms that use In-House Counsel to help structure their bond issue and those that use Big 4 Auditors are also less likely to include Default Indicating covenants in their bonds. Further tests show that the use of these Default Indicating covenants is associated with higher bond and CDS spreads. Overall, the results help explain the prior evidence on the relation between covenant use and the cost of debt.

Keywords: Survival analysis, Bond covenants, Bankruptcy risk, Cost of debt

JEL Classification: G12, G33, G34

Suggested Citation

Mansi, Sattar and Qi, Yaxuan and Wald, John K., Bond Covenants, Bankruptcy Risk, and the Cost of Debt (November 23, 2020). Available at SSRN: https://ssrn.com/abstract=3736019 or http://dx.doi.org/10.2139/ssrn.3736019

Sattar Mansi (Contact Author)

Virginia Polytechnic Institute & State University ( email )

Yaxuan Qi

City University of Hong Kong (CityU) - Department of Economics & Finance ( email )

83 Tat Chee Avenue
Kowloon
Hong Kong

John K. Wald

University of Texas at San Antonio ( email )

1 UTSA Circle
San Antonio, TX 78249
United States
210-458-6324 (Phone)

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