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Do Borrowers Intentionally Avoid Covenant Violations? A Reexamination of the Debt Covenant Hypothesis

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  • ADAM BORDEMAN
  • PETER DEMERJIAN

Abstract

In this study, we replicate and extend the Dichev and Skinner [DS: 2002] study on the debt covenant hypothesis (DCH). We start by replicating DS and find results consistent with theirs. We then extend their work by changing three aspects of the research design: histogram bin width, calculation of slack, and statistical test of discontinuity. We find that the inference from DS is generally robust to varying these choices, although sensitive to different bin widths, during their sample period. We extend our analysis to the period 2000–2019 and find that support for DCH remains robust. We do, however, find a lack of support for DCH when examining the most common financial covenant, debt‐to‐EBITDA. These findings suggest a more nuanced perspective on DCH, whereby different types of financial covenants provide different incentives and abilities to avoid technical default.

Suggested Citation

  • Adam Bordeman & Peter Demerjian, 2022. "Do Borrowers Intentionally Avoid Covenant Violations? A Reexamination of the Debt Covenant Hypothesis," Journal of Accounting Research, Wiley Blackwell, vol. 60(5), pages 1741-1774, December.
    • Handle: RePEc:bla:joares:v:60:y:2022:i:5:p:1741-1774
    DOI: 10.1111/1475-679X.12456
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