Debt covenants and the expected cost of technical default



Publishing details

Social Sciences Research Network

Authors / Editors

Ertan A; Karolyi S


Publication Year



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.


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


Social Sciences Research Network