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Why do loans contain covenants? Evidence from lending relationships

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  • Prilmeier, Robert

Abstract

Despite the importance of banks’ role as delegated monitors, little is known about how non-price terms of loan contracts are structured to optimize information production in a lending relationship. Using a large sample of corporate loans, this paper examines the effect of relationship lending on covenant choice. Consistent with information asymmetry theories, covenant tightness is relaxed over the duration of a relationship, especially for opaque borrowers. In contrast, the effect of lending relationship intensity on the number of covenants included in a loan follows an inverted U shape. I discuss potential explanations for this finding.

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  • Prilmeier, Robert, 2017. "Why do loans contain covenants? Evidence from lending relationships," Journal of Financial Economics, Elsevier, vol. 123(3), pages 558-579.
    • Handle: RePEc:eee:jfinec:v:123:y:2017:i:3:p:558-579
    DOI: 10.1016/j.jfineco.2016.12.007
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    More about this item

    Keywords

    Relationships; Banking; Covenants; Information asymmetries; Monitoring incentives;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation

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