Large–Sample Evidence on the Debt Covenant Hypothesis

Abstract

We use Dealscan, a database of private corporate lending agreements, to provide large–sample tests of the debt covenant hypothesis. Dealscan offers several advantages over the data available in previous studies, principally larger and more representative samples and the availability of extensive actual covenant detail. These advantages allow us to construct powerful tests in which we find clear support for the debt covenant hypothesis. We also use these data to provide broad evidence on the economic role of debt covenants. We find that private lenders set debt covenants tightly and use them as “trip wires” for borrowers, that technical violations occur relatively often, and that violations are not necessarily associated with financial distress. Finally, since we measure covenant slack directly, we report evidence that the extensively–used leverage variable is a relatively noisy proxy for closeness to covenants.

Determinants of Goodwill Impairment Losses under IAS 36: The French Case

“…Prior literature results about earnings management (Defond & Jiambalvo, 1994;Dichev & Skinner, 2002;Gu et al, 2005;Ben Othman & Zeghal, 2006) are in line with debt-covenant assumption. As such, managers are motivated to delay an existing goodwill impairment charge because this loss will lower the firm earnings.…”

Structure and Determinants of Financial Covenants in Leveraged Buyouts*

“…For example, a typical financial covenant, particularly used in LBOs, is a covenant limiting the maximum ratio of the debt to earnings before interest, tax, de- See for example Jensen (1986), Axelson, et al (2010), Demiroglu/James (2010b), Ivashina/Kovner (2010). 10 See for example Chen/Wei (1993), Sweeney (1994), Beneish/Press (1995), Dichev/Skinner (2002), Chava/Roberts (2008). 11 Cf.…”

Why Do Companies From Emerging Countries Manage Earnings?

“…This evidence is widely confirmed by the literature. Press and Weintrop (1990), Dichev and Skinner (2002), and Beatty et al (2002) provide evidence that high leverage is positively associated with the likelihood of violating debt covenants. Sweeney (1994) and DeFond and Jiambalvo (1994) also explain that firms near default employ incomeincreasing accounting changes in order to delay their technical default.…”

“…They hypothesize that managers try to influence contractual outcomes of bonus plans and debt covenants and reduce political costs by exercising judgement over accounting variables. Broad literature evaluates earnings management influenced by contractual incentives, see for example, Healy (1985), Watts and Zimmerman (1986), DeAngelo et al (1992), Sweeney (1994), DeFond and Jiambalvo (1994), Holthausen et al (1995), Dichev and Skinner (2002), Ball and Shivakumar (2006), Chen (2010), among others.…”

“…The literature suggests that debt structure plays an important role as a managerial incentive mechanism. Managers may manage earnings to meet certain debt covenant agreements, see for example, studies of DeFond and Jiambalvo (1994), Becker et al (1998), Dichev and Skinner (2002), Jaggi and Lee (2002), Othman and Zhegal (2006), Ardison et al (2012).…”