Similarity in the restrictiveness of bond covenants
Journal
European Accounting Review
Subject
Accounting
Publishing details
Authors / Editors
de Franco G;Vasvari F P;Vyas D;Wittenberg-Moerman R
Biographies
Publication Year
2019
Abstract
We examine the economic determinants and consequences associated with the inclusion of covenants with similar levels of restrictiveness in bond contracts. Using a unique Moody’s bond covenant dataset, we develop measures that capture similarity in the restrictiveness of bond covenants relative to previously issued peer bonds. We document that the demand for similarity by issuers, their advisors and bond investors follows the predictions of sociological and economic theories. Further, consistent with similarity in covenants reducing bond investors’ information acquisition and processing costs, we show that bonds with more similar covenant restrictiveness receive lower yields at issuance. These bonds are also more likely to be held by long-term bond investors, such as insurance companies, and are characterized by greater liquidity in the secondary market, providing a partial explanation for the lower bond yields. Our results highlight the benefits of covenant similarity and suggest that the use of covenants with similar restrictiveness levels brings information acquisition and processing cost savings that may be larger than the monitoring benefits provided by covenants with more tailored features.
Keywords
Bond covenants; Covenant restrictiveness; Similarity; Primary bond prices, Secondary bond liquidity
Available on ECCH
No