Debt Covenant Violations and Trade Credit

Abstract

This study examines the consequences of conflicts between creditors. Using the setting of debt covenant violations, I investigate how bank interventions on their borrowers affect the borrowers' trade credit. The results show that trade credit experiences a substantial decline when banks intervene in the borrowing firm following debt covenant violations. Furthermore, the decline is mitigated by the presence of dependent suppliers and relationship banks. Finally, such creditor conflicts are reflected in the loan contract design. Borrowing firms would sign less restrictive loan contracts when they rely more on trade credit. Overall, the study suggests that conflicts between creditors, which are largely ignored in the literature, are consequential.