Voluntary Bank Debt Renegotiation and Bondholders' Wealth

Abstract

I utilize bondholder wealth and corporate investment e ffects to test theories of why voluntary bank debt renegotiation happens without any default. Bondholders react positively to renegotiations that relax loan covenants, consistent with Gârleanu and Zwiebel (2009) that lenders transfer control rights back to the firm upon receiving favorable credit information. Positive bondholder reaction also rejects the alternative hypothesis that relaxing covenants signals weakened bank monitoring. Bondholders do not have a negative reaction to the renegotiated loan spread increase. Firms also invest more conservatively after such renegotiations. These results fail to support Gorton and Kahn (2000) that increased loan spread signals that asset substitution cannot be avoided. Lastly, I find that debt overhang is reduced following loan renegotiations that relax covenants.