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Do Creditor Rights Increase Employment Risk? Evidence from Loan Covenants

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  • ANTONIO FALATO
  • NELLIE LIANG

Abstract

Using a regression discontinuity design, we provide evidence that there are sharp and substantial employment cuts following loan covenant violations, when creditors gain rights to accelerate, restructure, or terminate a loan. The cuts are larger at firms with higher financing frictions and with weaker employee bargaining power, and during industry and macroeconomic downturns, when employees have fewer job opportunities. Union elections that create new labor bargaining units lead to higher loan spreads, consistent with creditors requiring compensation when employees gain bargaining power. Overall, binding financial contracts have a large impact on employees and are an amplification mechanism of economic downturns.

Suggested Citation

  • Antonio Falato & Nellie Liang, 2016. "Do Creditor Rights Increase Employment Risk? Evidence from Loan Covenants," Journal of Finance, American Finance Association, vol. 71(6), pages 2545-2590, December.
    • Handle: RePEc:bla:jfinan:v:71:y:2016:i:6:p:2545-2590
    DOI: 10.1111/jofi.12435
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