The Costs of Debt Contracts and the Repeated Use of Debt Covenants

Abstract

AbstractI examine the tendency to repeatedly use the same financial covenant in debt contracts and the economic determinants of such repeated use. Using the Dealscan database, I find a tendency to repeatedly use the same financial covenant. I also find that this tendency becomes stronger when a lender has high search costs for an informative covenant or high negotiation costs. I further find that this tendency becomes weaker when a borrower has a high risk of default. My study provides evidence that the cost of writing a contract is economically meaningful and needs to be considered to avoid overstating the effect of accounting informativeness on covenant choice.