Anticipating Binding Constraints: An Analysis of Debt Covenants

42 Pages Posted: 4 Aug 2022 Last revised: 6 Jan 2025

See all articles by Ken Teoh

Ken Teoh

International Monetary Fund (IMF) - Research Department

Date Written: July 26, 2022

Abstract

This paper shows that anticipation can meaningfully impact inferences about the effects of covenant violations. Using textual analysis of SEC filings and earnings call transcripts, I construct a measure of covenant concerns that identifies instances where firms disclose forward-looking risks related to their debt covenants. On average, nearly 30 percent of U.S. non-financial firms report covenant concerns each year. While covenant violations have significant real effects, the anticipation of such violations can lead to an overestimation of their impact on some outcomes like acquisitions, employment growth, and default risk. This finding suggests that selection into violation, where firms that successfully avoid violations differ systematically from those that do not, can be severe when there is anticipation.

Keywords: debt covenants, investments, textual analysis, earnings calls

JEL Classification: G21, G31, G32

Suggested Citation

Teoh, Ken, Anticipating Binding Constraints: An Analysis of Debt Covenants (July 26, 2022). Available at SSRN: https://ssrn.com/abstract=4173540 or http://dx.doi.org/10.2139/ssrn.4173540

Ken Teoh (Contact Author)

International Monetary Fund (IMF) - Research Department ( email )

700 19th Street NW
Washington, DC 20431
United States

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