An Empirical Exploration Of Financial Covenants In Large Bank Loans

Abstract

Financial covenants in large bank loans are used to study how banks use contractual restrictions to
\nreduce potential agency problems and financial distress costs. Using an extensive database developed
\nfrom bank loan contracts written between 1992 and 1994, we find that financial covenant use
\nand “tightness” are affected by potential agency problems, information asymmetries, incentives to
\nmonitor, and growth opportunities. Consistent with previous research, collateral signals higher risk
\nis associated with more covenants. Other factors affecting covenant tightness, which have been
\nelusive in the literature due to a general lack of data, are reported.