Debt Covenants and Capital Structure: Evidence from an Exogenous Shock to Debt Capacity
Coauthor(s): Moshe Cohen, Gil Sadka.
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This paper empirically examines how debt covenants impact the capital structure
firms, by utilizing an exogenous accounting based shock to the distance to
covenant violation. We
find that, on average, the shock to debt capacity had a positive
impact on the debt choices of all treated fi
rms, but the response was strongest by
firms that were close to violating or in violation of the affected covenants, and that
financially unconstrained. Our
findings suggest that debt covenants
are a key component of the capital structure trade-off that influences debt choices well
before they are triggered. We proceed to examine how the additional debt affected
financial behavior and
find that it did not result in an increase in
investments or cash holdings, but rather was associated with lower pro
a lower likelihood to enter default or bankruptcy. Some
firms even maintained or
increased their dividend payouts.
Source: Working Paper
Cohen, Moshe, Sharon Katz, and Gil Sadka. "Debt Covenants and Capital Structure: Evidence from an Exogenous Shock to Debt Capacity." Working Paper, Columbia Business School, 2012.