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Debt covenants and the expected cost of technical default

Subject

Accounting

Publishing details

Social Sciences Research Network

Authors / Editors

Ertan A;Karolyi S

Biographies

Publication Year

2016

Abstract

To estimate the expected cost of technical default for equityholders, we analyze the stock market reaction to changes in the ex-ante likelihood of technical default. Our large-sample, ex-ante estimates exceed five percent of equity value, which reflects material monetary and risk consequences of lender control. Small-sample, ex-post estimates using market reactions to default announcements are smaller, consistent with anticipation and selection. In cross-sectional tests, we find that equityholders anticipate technical defaults and that renegotiating borrowers' ex-ante expected technical default costs exceed that of defaulters. Moreover, we show that creditor coordination and monitoring problems increase the expected cost of default.

Keywords

Debt covenants; Technical default; Control rights; Shareholder-debtholder conflict

Series

Social Sciences Research Network

Available on ECCH

No


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