Costs of Financial Distress and Interest Coverage Ratios
Posted: 22 Mar 2005
Creditors routinely impose on a borrowing firm a minimum interest coverage ratio that the firm has to maintain. I show that nonlinear costs of financial distress provide a possible explanation of why firms find it optimal to have an interest coverage ratio covenant in their debt indenture, even in the absence of information asymmetries or agency costs.
Keywords: financial distress, bond covenants
JEL Classification: G12, G32, G33
Suggested Citation: Suggested Citation