The Information Content of Bank Loan Covenants

AFA 2008 New Orleans Meetings

Review of Financial Studies, Forthcoming

49 Pages Posted: 30 Jan 2007 Last revised: 8 Mar 2010

See all articles by Cem Demiroglu

Cem Demiroglu

Koc University, College of Administrative Sciences and Economics

Christopher M. James

University of Florida - Department of Finance, Insurance and Real Estate

Date Written: March 5, 2010

Abstract

This paper examines the determinants of financial covenant thresholds in bank loan agreements and information conveyed through the selection of tight financial covenants. We find that riskier firms and firms with fewer investment opportunities select tighter financial covenants. We also find that selection of tight covenants is associated with improvements in the covenant variable and declines in investment spending and net debt issuance. We observe these changes also for borrowers that do not breach their covenants, suggesting that they are not simply the result of creditor influence conditional on a technical default. Furthermore, we find that violations of tightly set covenants have significantly less of an impact on the borrower’s investment spending and net debt issuance than violations of loosely set covenants. Overall, our results suggest that the selection of tight covenants conveys information concerning future changes in covenant variables and the outcome of covenant violations.

Keywords: bank lending, loan contracting, covenants, congruence

JEL Classification: G21, G32

Suggested Citation

Demiroglu, Cem and James, Christopher M., The Information Content of Bank Loan Covenants (March 5, 2010). AFA 2008 New Orleans Meetings. Available at SSRN: https://ssrn.com/abstract=959393 or http://dx.doi.org/10.2139/ssrn.959393

Cem Demiroglu (Contact Author)

Koc University, College of Administrative Sciences and Economics ( email )

Koc University
Sariyer
Istanbul, 34450
Turkey
90-212-338-1620 (Phone)
90-212-338-1653 (Fax)

HOME PAGE: http://https://sites.google.com/site/cemdemiroglu/

Christopher M. James

University of Florida - Department of Finance, Insurance and Real Estate ( email )

P.O. Box 117168
Gainesville, FL 32611-7168
United States
352-392-3486 (Phone)
352-392-0301 (Fax)

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