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Debt covenant violation, competition and cost of new debt

Author

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  • Umar Butt

Abstract

This article empirically shows that the cost of new debt is higher for firms that commit covenant violations. Using a proxy for product market competition to capture exogenous changes to a firm’s competitive environment, I find that the cost is systematically higher for firms that operate in competitive markets. Moreover, I identify channels through which violations can increase the cost of new debt, namely, the incidence, timing and frequency effects , and I document these effects to be more acute for competitive markets. Overall, the study finds that the market prices financial contracts by taking into account the information content of the violation and the risk arising from market competition. JEL Classification: G12, G30

Suggested Citation

  • Umar Butt, 2019. "Debt covenant violation, competition and cost of new debt," Australian Journal of Management, Australian School of Business, vol. 44(2), pages 163-187, May.
    • Handle: RePEc:sae:ausman:v:44:y:2019:i:2:p:163-187
    DOI: 10.1177/0312896218805789
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    References listed on IDEAS

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    More about this item

    Keywords

    Cost of debt; debt covenant violation; market competition;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G30 - Financial Economics - - Corporate Finance and Governance - - - General

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