Dynamic threshold values in earnings-based covenants

Li, N, Vasvari, F and Wittenberg-Moerman, R (2016) Dynamic threshold values in earnings-based covenants. Journal of Accounting and Economics, 61 (2-3). pp. 605-629. ISSN 0165-4101

Abstract

We examine the role of dynamic covenant threshold values in syndicated loan agreements. We document that 45% of syndicated loans specify dynamic covenant thresholds in earnings-based covenants and that these changing thresholds typically become tighter over the life of a loan. We find that covenants with a tight trend provide an important signaling mechanism that meets the needs of borrowers that experience an inferior financial performance at loan initiation but expect future performance improvements. Specifically, we find that these covenants provide underperforming borrowers with a grace period by requiring less restrictive initial thresholds. At the same time, they allow these borrowers to credibly convey information to lenders about their future prospects via gradually more demanding subsequent thresholds. Our empirical evidence also suggests that while lenders entering into tight threshold trend covenant contracts receive weaker covenant protection over the grace period, they benefit from having stronger control rights in subsequent periods.

More Details

Item Type: Article
Subject Areas: Accounting
Additional Information:

© 2016 Elsevier

Date Deposited: 02 Mar 2016 18:51
Last Modified: 30 May 2024 00:46
URI: https://lbsresearch.london.edu/id/eprint/112
More

Export and Share


Download

Full text not available from this repository.

Statistics

Altmetrics
View details on Dimensions' website

Downloads from LBS Research Online

View details

Actions (login required)

Edit Item Edit Item