Private lenders' use of analyst earnings forecasts when establishing debt covenant thresholds

We examine whether lenders use analyst forecasts of the borrower's earnings as inputs when establishing covenant thresholds in private debt contracts. We find that, among debt contracts that include an earnings covenant, earnings thresholds are set closer to analyst forecasts when analysts have historically issued more accurate earnings forecasts. These results are robust to firm fixed effects and an instrumental variable approach. Further, we find that, following a plausibly exogenous decline in the availability of analyst earnings forecasts, debt contracts are less likely to include earnings covenants. Our evidence is consistent with lenders using analyst earnings forecasts as an input when establishing debt covenant thresholds and suggests sell-side analysts play a role in debt contracting.

Corporate Bankruptcy and Directors’ Reputation: An Empirical Analysis of the Effects on Public Debt Contracts

This article investigates the link between board members’ past professional experiences and the terms and conditions of the debt contracts of their current firms. In particular, we examine whether directors’ past bankruptcy experience affects the pricing and nonpricing terms of public debt contracts. Using a sample of 8,142 bond issues in the United States in the period 1995 to 2015, we document higher credit spreads and smaller bond sizes for firms with such directors, suggesting that bondholders are concerned about past bankruptcy experience. Our results remain robust to different model specifications. This effect is moderated for bankruptcies that are likely driven by macroeconomic shocks such as the dotcom bubble and the global financial crisis. We also show that our findings are not explained by bond issuers with an elevated risk of default and seem instead to be driven by directors serving on key monitoring committees, indicating that prior bankruptcy experience raises concerns about the company’s corporate governance. Finally, mediation analysis offers some evidence of a limited negative indirect effect of prior bankruptcy experience on the terms of debt contracts through the firm’s financial and investment policies. Overall, our findings suggest that lenders incorporate information about past professional experiences of directors into public debt contracting.

The Rise of Covenant-Lite Bond Contracting

We investigate the trading and yield effects of covenant-lite (cov-lite) high-yield bond contracts, which have a restricted (lite) set of covenants. The excluded covenants often are those that use accounting performance measures. Although much research has focused on the potential benefits of accounting as a basis for debt contracting, little is known about settings where it may be optimal to exclude accounting performance statistics from public debt contracts. We find that cov-lite high-yield bonds have a higher trading turnover and lower yield spreads. Our findings provide empirical support for theory, which predicts, for optimal bond covenant design, that a trade-off between improving trading ease versus enhanced investor protection needs to be managed. These results enhance our understanding of the limits of accounting’s role in (bond) contracting design.