Debt Covenant Design and Creditor Control Rights: Evidence from Covenant Restrictiveness and Loan Outcomes

Using three measures of covenant restrictiveness, I examine the association between the ex ante design of debt covenant restrictiveness and the ex post exercise of creditor control rights. I find that contracts with higher level of covenant restrictiveness at loan origination are more likely to subsequently experience both covenant violations and renegotiations, suggesting that stricter covenants translate into more frequent exercise of creditor control rights. Further, I find that the specific channel through which creditor control rights are exercised is influenced by the type of the most restrictive covenant in the original contract. Overall, my results imply that the ex ante design of covenant restrictiveness plays an important role in the ex post transfer of control rights. * I thank David Denis, Mara Faccio, John McConnell, Jin Xu and Deniz Yavuz and seminar participants at Purdue University for helpful comments and suggestions. † Department of Finance, Fisher College of Business, Ohio State University, Columbus, OH 43210. Email: [email protected].