infonet-economy

This paper analyzes the impact of debt covenant renegotiations on corporate policies. We develop a structural model of a levered firm that can renegotiate debt both at investment and in corporate distress. Covenant renegotiation at investment disciplines equity holders in their financing and investment decisions and, hence, mitigates the agency cost of debt. Our model explains the empirical intensity and patterns of the occurrence of debt renegotiation. We
also quantify the role of debt covenant renegotiations as a governance channel on corporate financial policies and on the value of corporate securities. Additionally, the model offers a rich set of novel testable predictions.