Bank Interventions and Trade Credit: Evidence from Debt Covenant Violations

Abstract

This study examines the consequences of conflicts between creditors. Using the setting of debt covenant violations, I employ a regression discontinuity design to identify the effect of banks’ interventions on their borrowers’ trade credit. The results show that trade credit experiences a substantial decline when banks intervene in the borrowing firm following covenant violations. The decline is mitigated by the presence of dependent suppliers and exacerbated by banks’ incentives to exercise control rights. Such externalities are reflected in the loan-contract design. Borrowing firms sign less restrictive loan contracts when they rely more on trade credit or trade creditors.