Abstract
This paper studies how covenants affect the speed of capital structure adjustment in Brazil, an environment with poor creditor rights. Unlike previous evidence for developed countries, we find that the existence of debt covenants increases the speed of capital structure adjustment by more than 20% for firms that are only domestically listed. For firms that are cross-listed in the US, this effect is smaller (if any), possibly because these firms “bond” to the stricter regulation and creditor protection of the US market. Our results suggest that in emerging markets with poor creditor protection, covenants are an imperfect substitute for strong creditor rights and employed as a signaling device, permitting firms to adjust their leverage towards optimal levels quicker.
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