Does Borrowing from the Private Bond Market Cost More than Borrowing from the Public Bond Market?
We investigate the pricing of private versus public placement bonds, using a novel data set, and test the effect of covenants on yield spreads in the primary market. The observed yield spread premium of 116 basis points is partially explained by credit risk but equally important, by the use of covenants. We provide evidence of a U shape effect of covenant intensity on spread, the downward sloping part explained by investment covenants, the upward sloping part by financing covenants. The use of covenants has as much explanatory power beyond credit risk as liquidity and market conditions together, providing direct evidence of firm's willingness to pay for options providing renegotiation flexibility.