How Does Financing Impact Investment? The Role of Debt Covenants
61 Pages Posted: 26 Nov 2005
Date Written: August 2, 2007
We identify a specific channel (debt covenants) and the corresponding mechanism (transfer of control rights) through which financing frictions impact corporate investment. Using a regression discontinuity design, we show that capital investment declines sharply following a financial covenant violation, when creditors use the threat of accelerating the loan to intervene in management. Further, the reduction in investment is concentrated in situations where agency and information problems are relatively more severe, highlighting how the state contingent allocation of control rights can help mitigate investment distortions arising from financing frictions.
Keywords: Investment, Covenant, Debt, Contracts, Renegotiation, Default, Control Rights
JEL Classification: G31, G33, G21, G32
Suggested Citation: Suggested Citation