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Contracting Costs, Covenant-Lite Lending, and Reputational Capital

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  • Badoer, Dominique C.
  • Emin, Mustafa
  • James, Christopher M.

Abstract

Using a large sample of leveraged loans, we provide evidence that, despite having fewer creditor control rights, covenant-lite (Cov-Lite) loans have similar recovery rates and significantly lower spreads than loans with maintenance covenants. We find that the propensity to borrow Cov-Lite is related to various proxies for the reputational capital of a borrowing firm’s private equity sponsor. We construct a simple model to illustrate the relationship between reputational capital, covenants, and loan spreads in the leveraged loan market. Our model illustrates how reputational capital can substitute for covenants in mitigating agency costs of debt, leading to lower loan spreads for Cov-Lite loans.

Suggested Citation

  • Badoer, Dominique C. & Emin, Mustafa & James, Christopher M., 2024. "Contracting Costs, Covenant-Lite Lending, and Reputational Capital," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 59(7), pages 3376-3415, November.
    • Handle: RePEc:cup:jfinqa:v:59:y:2024:i:7:p:3376-3415_11
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