State Laws and Debt Covenants
Posted: 7 Nov 2006
We examine whether state laws impact the use of debt covenants using a sample of U.S. public bond issues from 1987 to 2004. We consider variation in state laws with respect to the minimum asset/debt ratio necessary for a payout and with respect to antitakeover statutes. We find that firms incorporated in states with stricter restrictions on distributions are less likely to include debt covenants which constrain payouts, limit additional debt, or restrict the sale of assets. Thus state payout restrictions appear to substitute for the use of these debt covenants. On the other hand, firms incorporated in states with stronger antitakeover statutes are somewhat more likely to use debt covenants. This finding is consistent with the notion that firms with antitakeover protection are more likely to suffer from agency problems, and hence are more likely to use debt covenants to minimize agency costs.
Keywords: state laws, covenants, payout restrictions, agency costs
JEL Classification: G35, K22
Suggested Citation: Suggested Citation