Accounting and Finance Seminars: Isin Adnan (University of Exeter)
G.15, 15-19 Tyndalls Park Road
Title: Covenant Quality Erosion and Financial Reporting Aggressiveness: Evidence from Covenant-lite Issues
Examining syndicated loans for publicly traded U.S. firms, we document a positive link between covenant-lite deals, which possess sub-optimal covenant compliance requirements, and aggressive financial reporting. Importantly, this positive link is largely offset for deals with performance pricing provisions and for firms with credit default swaps outstanding. Moreover, under ultra-flexible covenant compliance requirements, we find that both performance pricing provisions and credit default swaps facilitate stronger borrower-lender incentive alignment than can be achieved via standalone covenant strictness and lender reputation. Finally, the observed aggressive reporting incentives are indistinguishably similar for leveraged vs. non-leveraged covenant-lite issuers and for covenant-lite issuers with high/low quality external/internal corporate governance mechanisms in place. These results create an initial dialogue as to how the proclaimed covenant quality erosion via covenant-lite deals affect financial reporting incentives and should further contribute to the discussion of the topic at practitioner, academic and regulatory levels.