Creditor Control Rights and Firm Investment Policy

Nini, Greg; Sufi, Amir; Smith, David C.

doi:10.2139/ssrn.928688

Cited by 239 publications

(309 citation statements)

References 36 publications

(19 reference statements)

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“…This analysis is motivated by evidence in prior studies indicating a potential miscoding problem in covenant data in DealScan (e.g., Nini, Smith, and Sufi (2009)). Specifically, some loans coded as having missing data or no covenant restrictions may actually contain covenant restrictions.…”

Section: Table 7 Social Capital and Nonprice Loan Termsmentioning

confidence: 99%

Social Capital and Debt Contracting: Evidence from Bank Loans and Public Bonds

Hasan

Hoi

et al. 2017

J. Financ. Quant. Anal.

419

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We find that firms headquartered in U.S. counties with higher levels of social capital incur lower bank loan spreads. This finding is robust to using organ donation as an alternative social capital measure and incremental to the effects of religiosity, corporate social responsibility, and tax avoidance. We identify the causal relation using companies with a social-capital-changing headquarters relocation. We also find that high-social-capital firms face loosened nonprice loan terms, incur lower at-issue bond spreads, and prefer public bonds over bank loans. We conclude that debt holders perceive social capital as providing environmental pressure that constrains opportunistic firm behaviors in debt contracting.

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Section: Table 7 Social Capital and Nonprice Loan Termsmentioning

confidence: 99%

Social Capital and Debt Contracting: Evidence from Bank Loans and Public Bonds

Hasan

Hoi

et al. 2017

J. Financ. Quant. Anal.

419

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“…Furthermore, allowing the withdrawal limit to depend on the cash balance is also very natural. In practice, such limits are often imposed through reinvestment or incurrence-based covenants, i.e., covenants that become active only when the borrower seeks to issue new debt, and limit the new loan size depending on the pre-existing debt and cash funds (see, e.g., Nini et al (2009) and industry notes by Goodison (2011) and Morse (2014) for more details).…”

Section: Partial Liquidation and Replenishmentmentioning

confidence: 99%

Is Operating Flexibility Harmful Under Debt?

2017

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We study the inefficiencies stemming from a firm's operating flexibility under debt. We find that flexibility in replenishing or liquidating inventory, by providing risk-shifting incentives, could lead to borrowing costs that erase more than one-third of the firm's value. In this context, we examine the effectiveness of practical and widely used covenants in restoring firm value by limiting such risk-shifting behavior. We find that simple financial covenants can fully restore value for a firm that possesses a midseason inventory liquidation option. In the presence of added flexibility in replenishing or partially liquidating inventory, financial covenants fail, but simple borrowing base covenants successfully restore firm value. Explicitly characterizing optimal covenant tightness for all these cases, we find that better market conditions, such as lower inventory depreciation rate, higher gross margins, or increased product demand, are typically associated with tighter covenants. Our results suggest that inventory-heavy firms can reap the full benefits of additional operating flexibility, irrespective of their leverage, by entering simple debt contracts of the type commonly employed in practice. For such contracts to be effective, however, firms with enhanced flexibility and/or operating in better markets must also be willing to abide by more and/or tighter covenants. AbstractWe study the inefficiencies stemming from a firm's operating flexibility under debt. We find that flexibility in replenishing or liquidating inventory, by providing risk shifting incentives, could lead to borrowing costs that erase more than a third of the firm's value. In this context, we examine the effectiveness of practical and widely used covenants in restoring firm value by limiting such risk shifting behavior. We find that simple financial covenants can fully restore value for a firm that possesses a mid-season inventory liquidation option. In the presence of added flexibility in replenishing or partially liquidating inventory, financial covenants fail, but simple borrowing base covenants successfully restore firm value. Explicitly characterizing optimal covenant tightness for all these cases, we find that better market conditions, such as lower inventory depreciation rate, higher gross margins or increased product demand, are typically associated with tighter covenants. Our results suggest that inventory-heavy firms can reap the full benefits of additional operating flexibility, irrespective of their leverage, by entering simple debt contracts of the type commonly employed in practice. For such contracts to be effective, however, firms with enhanced flexibility and/or operating in better markets must also be willing to abide by more and/or tighter covenants.

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“…As discussed in Nini, Smith, and Sufi (2009), this type of covenant explicitly limits firms' capital expenditures and often also imposes restrictions on deal activation date is less than four months after the fiscal year ending month, I use the data from the fiscal year ending in calendar year t-1.…”

Section: Flexibility-reducing Covenantsmentioning

confidence: 99%

Renegotiation and the Choice of Covenants in Debt Contracts

Saavedra

2015

SSRN Journal

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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 valueenhancing 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.

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Creditor Control Rights and Firm Investment Policy

Cited by 239 publications

References 36 publications

Social Capital and Debt Contracting: Evidence from Bank Loans and Public Bonds

Social Capital and Debt Contracting: Evidence from Bank Loans and Public Bonds

Is Operating Flexibility Harmful Under Debt?

Renegotiation and the Choice of Covenants in Debt Contracts

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