Abstract
This paper estimates the legal effect of covenant strictness on syndicated loan spreads, where the former results from creditor's consideration of bankruptcy law. To do so, we first provide a framework linking creditor control inside and outside of bankruptcy. We then use variations in the usage of some bankruptcy practices as instruments, and show that such an effect accounts for a sizeable portion of the total cost of credit. We finally provide an additional rationale for creditors to include covenants outside of bankruptcy: the adjustment of their level of monitoring depending on the current state of the legal practice. This rationale would then coexist with the traditional justification based on control and ownership theory.
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