Private Equity and Debt Contract Enforcement: Evidence from Covenant Violations 

62 Pages Posted: 17 Feb 2023 Last revised: 12 Jun 2024

See all articles by Sharjil Haque

Sharjil Haque

Board of Governors of the Federal Reserve System

Anya Kleymenova

Board of Governors of the Federal Reserve System

Date Written: February 1, 2023

Abstract

We study the role of private equity (PE) sponsors in debt contract enforcement when firms violate loan covenants. Using the Shared National Credit supervisory data, we find Private Equity (PE) sponsored firms violate covenants more often than comparable non-PE firms. However, upon covenant violation, PE-sponsored borrowers experience relatively smaller reductions in credit commitments, suggesting lenders are more lenient with these borrowers. Consistent with this limited-punishment effect, sponsor-backed borrowers experience a smaller increase in loan spread and a smaller reduction in loan maturity upon covenant violations. Limited punishment is driven by the lender's prior relationship with a sponsor through repeated deals, as well as the higher bargaining power of sponsors in loan renegotiation. Overall, our results suggest that the rise of PE sponsors has altered the traditional paradigm whereby creditors use covenant violations to exert control over distressed borrowers.

Keywords: JEL Classification: G21, G23, G32 Private Equity, Covenants, Loan Renegotiation, Covenant Violations, Syndicated Loans

JEL Classification: G00; G10; G30; G32; G33

Suggested Citation

Haque, Sharjil and Kleymenova, Anya V., Private Equity and Debt Contract Enforcement: Evidence from Covenant Violations  (February 1, 2023). Available at SSRN: https://ssrn.com/abstract=4361582 or http://dx.doi.org/10.2139/ssrn.4361582

Sharjil Haque (Contact Author)

Board of Governors of the Federal Reserve System ( email )

Anya V. Kleymenova

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States
202-452-2662 (Phone)

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