Design And Renegotiation Of Debt Covenants
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| Author | : Nicolae Garleanu |
| Publisher | : |
| Total Pages | : 36 |
| Release | : 2005 |
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We analyze the design and renegotiation of covenants in debt contracts as a particular example of the contractual assignment of property rights under asymmetric information. In particular, we consider a setting where future firm investments are efficient in some states, but also involve a transfer from the lender(s) to shareholders. While there is symmetric information regarding investment efficiency, managers are better informed about any potential transfer than the lender. The lender can learn this information, but at a cost. In this setting, we show that the simple adverse selection problem leads to the allocation of greater ex-ante decision rights to the uninformed party than would follow under symmetric (in particular, full) information. Consequently, ex-post renegotiation is in turn biased towards the uninformed party giving up these excessive rights. In many settings, this result yields the opposite implication from standard Property Rights results regarding contracting under incomplete contracts and ex-ante investments, whereby rights should be allocated to minimize inefficiencies due to distortions in ex-ante investments. Indeed, for debt contracts as well as other settings, the uninformed party, who receives strong decision rights in our setting, is likely to have few significant ex-ante investments to undertake relative to the informed party.
| Author | : Nicolae Gârleanu |
| Publisher | : |
| Total Pages | : |
| Release | : 2010 |
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We analyze the design and renegotiation of covenants in debt contracts as a specific example of the contractual assignment of property rights under asymmetric information. Specifically, we consider a setting where managers are better informed than lenders regarding potential transfers from debt to equity associated with future investments. This simple adverse-selection problem leads to the allocation of greater ex ante decision rights to the creditor (the uninformed party), i.e., tighter covenants, than would follow under symmetric information. This corresponds well to empirical evidence indicating that covenants are very tight upon inception and are frequently waived (and never tightened) upon renegotiation.
| Author | : Daniel Andres Saavedra Lux |
| Publisher | : |
| Total Pages | : 71 |
| Release | : 2015 |
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I investigate whether and how expected future contract renegotiation considerations affect the type of covenants used in ex-ante debt contracts. I find that when future contract renegotiation costs are expected to be high, debt contracts are less likely to include covenants that restrict the borrower's financial flexibility in good states. This finding suggests that when renegotiation costs are high, borrowers and lenders avoid the use of covenants that are more likely to hold up the borrower and force it to bypass value-enhancing corporate policies (e.g., investments). Consistent with this interpretation, the negative relationship between renegotiation costs and the presence of flexibility-reducing covenants becomes stronger when the borrower has fewer outside options and financial flexibility becomes more valuable. Finally, I find that when future renegotiation costs are expected to be high, debt contracts have more covenants that are directly linked to the current performance of the borrower, which allows for a more efficient allocation of decision rights between the borrower and lenders. Overall, this study provides initial evidence about how renegotiation considerations affect the design of covenant packages in debt contracts.
| Author | : Elia Ferracuti |
| Publisher | : |
| Total Pages | : 68 |
| Release | : 2018 |
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| ISBN | : |
We exploit plausibly exogenous variation in the tax consequences of renegotiating U.S. syndicated loans to isolate the effect of renegotiation costs on initial contract terms. TD9599 materially reduced the tax burden of renegotiating U.S. syndicated loans, while leaving the taxation of renegotiating U.S. single-lender and non-U.S. syndicated loans unchanged. In this setting, we examine the implications of incomplete contracting theory for debt contract design. Consistent with incomplete contracting theory, we find that, as renegotiation costs fall, the maturity of debt contracts lengthens, the likelihood of covenant violation increases, and the use of performance pricing provisions becomes less frequent.
| Author | : Mitchell Berlin |
| Publisher | : |
| Total Pages | : 60 |
| Release | : 1992 |
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| Author | : Mitchell Berlin |
| Publisher | : |
| Total Pages | : 60 |
| Release | : 1992 |
| Genre | : Debt |
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| Author | : Mitchell Berlin |
| Publisher | : |
| Total Pages | : 51 |
| Release | : 1990 |
| Genre | : Debt |
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| Author | : David J. Denis |
| Publisher | : |
| Total Pages | : 56 |
| Release | : 2013 |
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Using a large sample of private debt renegotiations from 1996 to 2011, we report that, even in the absence of any covenant violation, debt covenants are frequently renegotiated. These renegotiations primarily relax existing restrictions and result in economically large changes in existing limits. Renegotiations of specific covenants are a response to both the distance the covenant variable is from its contractual limit and the firm's specific operating conditions and prospects. Moreover, the borrower's post-renegotiation investment and financial policies are strongly associated with the covenant changes resulting from the renegotiation. Overall, these findings imply that, even outside of default states, creditors have strong control rights over the borrower's operating and financial policies, and exercise these rights in a state contingent manner through covenant renegotiations.
| Author | : Redouane Elkamhi |
| Publisher | : |
| Total Pages | : 75 |
| Release | : 2015 |
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This article focuses on financial maintenance covenants as incentive instruments for borrowers under both moral hazard and adverse selection. We explain why maintenance covenants are conditioned on public information. We examine the effect of the firm's incentive to risk-shift, debt amount, and renegotiation costs on optimal covenants. In an extension of the model, we find that a reduction in financial signal quality 1) moves the equilibrium from pooling to separating, to no covenants at all, and 2) has a non-monotone effect on covenant strictness. We also allow for uncertainty in macroeconomic conditions and characterize state contingent covenants within our framework.
| Author | : Yiwei Dou |
| Publisher | : |
| Total Pages | : 48 |
| Release | : 2018 |
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| ISBN | : |
Building on incomplete contract theory, I investigate whether the likelihood of renegotiating financial covenants is affected by the debt-contracting value of borrowers' accounting numbers (DCV). DCV captures the inherent ability of accounting numbers to predict credit quality. Using a large sample of private credit agreements, I hypothesize and find that a higher DCV gives rise to smaller ex-post measurement errors in accounting numbers used in covenants, and thus borrowers and lenders are less likely to renegotiate financial covenants. This effect is stronger when the financial covenant intensity is higher. Consistent with the notion that renegotiation improves contracting efficiency by eliminating errors in financial covenants, I show that the distance of the covenant variable to its new contractual threshold better predicts a borrower's creditworthiness than does the distance to the original threshold absent the renegotiation.
