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Signaling through Dynamic Thresholds in Financial Covenants

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Title:Signaling through Dynamic Thresholds in Financial Covenants
Authors:Fang, Shunlan
Chava, Sudheer
Prabhat, Saumya
Keywords:loan covenant design
consequences of signaling
creditor control
information asymmetry
Date Issued:28 Aug 2017
Abstract:Among private loan contracts with covenants originated during 1996-2012, 35% have financial covenant thresholds that automatically increase according to a predetermined schedule. Firms that accept these dynamic thresholds receive a lower interest spread and improve their creditworthiness relative to matched control firms. However, in the event of a covenant violation, these firms are less likely to receive a waiver, more likely to pay higher waiver fees, experience greater investment cuts, and are more likely to switch lead lenders than control firms. Overall, our findings suggest that signaling through dynamic thresholds in covenants is credible but costly to borrowers.
Appears in Collections: 12 Financial: Labor Unions / Debt Financing / Political Connections / Information Risk (FAR4)

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