"Debt Covenants and Capital Structure: Evidence from an Exogenous Shock to Debt Capacity"

Moshe Cohen, Sharon Katz, Gil Sadka

Working Paper, 2012

Publication type: Working paper

Research Archive Topic: Accounting, Business Economics and Public Policy, Corporate Finance

Abstract

This paper empirically examines how debt covenants impact the capital structure choices of 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 firms, but the response was strongest by firms that were close to violating or in violation of the affected covenants, and that were otherwise 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 firms; corporate financial behavior and find that it did not result in an increase in investments or cash holdings, but rather was associated with lower profitability and a lower likelihood to enter default or bankruptcy. Some firms even maintained or increased their dividend payouts.

Download PDF

 

Each author name for a Columbia Business School faculty member is linked to a faculty research page, which lists additional publications by that faculty member.

Each topic is linked to an index of publications on that topic.