The rationale for our instruments is the following: the lender-level averages aim at determining a standard (boilerplate) contract offered by the lead arranger to various borrowers, that is expected to vary with lender’s preferences with respect to the use of accounting (and may in part be due to lender’s specialization). Some lenders are known to rely on covenants more than others (while others price protect instead). Thus, the use of covenants in a particular loan will be correlated with lead lender preferences, while at the same time the lead lender’s preference for covenant use is not a direct determinant of firms’ leverage (unless via the use of covenants, controlling for other characteristics). In other words, lender-level preferences/specialization conceptually is an appropriate instrument. Partial R-squareds indicating explanatory power of the instruments vary between 3.0 and 5.7%. The results of this analysis are presented in Table 11. The results are similar to those in Table 10 and even indicate a higher effect of on the level of debt financing. CovenantMix Overall, the results of our analysis provide evidence on the importance of accounting for debt contracting. The ability to use accounting-based benchmarks as an input into covenant provisions has a large economic effect on firms’ ability to access credit markets. 7. Conclusion In this paper we examine the effect of reliance on accounting-based benchmarks in private lending agreements on the level of debt. We argue that the use of accounting ratios in the definitions of financial covenants increases firms’ access to credit markets. Accounting-based covenants alleviate agency and information problems that arise in credit markets and thus facilitate borrowing. The ability of accounting information to reflect firms’ credit risk is shown to be an important determinant of covenants and their mix. Specifically, firms substitute to more
The rationale for our instruments is the following: the lender-level averages aim at determining a standard (boilerplate) contract offered by the lead arranger to various borrowers, that is expected to vary with lender’s preferences with respect to the use of accounting (and may in part be due to lender’s specialization). Some lenders are known to rely on covenants more than others (while others price protect instead). Thus, the use of covenants in a particular loan will be correlated with lead lender preferences, while at the same time the lead lender’s preference for covenant use is not a direct determinant of firms’ leverage (unless via the use of covenants, controlling for other characteristics). In other words, lender-level preferences/specialization conceptually is an appropriate instrument. Partial R-squareds indicating explanatory power of the instruments vary between 3.0 and 5.7%. The results of this analysis are presented in Table 11. The results are similar to those in Table 10 and even indicate a higher effect of CovenantMix on the level of debt financing. Overall, the results of our analysis provide evidence on the importance of accounting for debt contracting. The ability to use accounting-based benchmarks as an input into covenant provisions has a large economic effect on firms’ ability to access credit markets. 7. Conclusion In this paper we examine the effect of reliance on accounting-based benchmarks in private lending agreements on the level of debt. We argue that the use of accounting ratios in the definitions of financial covenants increases firms’ access to credit markets. Accounting-based covenants alleviate agency and information problems that arise in credit markets and thus facilitate borrowing. The ability of accounting information to reflect firms’ credit risk is shown to be an important determinant of covenants and their mix. Specifically, firms substitute to more
CovenantsCredit_Paper_HB7VN10.docx