Date of Award
Doctor of Philosophy (PhD)
My dissertation examines the financial contracting of corporate debt. One theme that runs through every chapter is the importance of covenants to the debt contracting process. Chapters 1 and 2 explore the way that covenants are used differentially by junior and senior debt both in practice and in theory. Chapter 3 looks at different classes of covenants and the distinct roles they play in the modern corporate debt contract. In the first chapter, I investigate the relative covenant usage of private bank loans and public bonds. I examine a novel dataset (created by machine-learning) of comparable debt contracts matched by firm and time and find that, between comparable contracts, there exists significant variation in which class of debt is better protected by covenants. This variation is driven by the way and the degree to which the debt capital structure is subordinated between senior and junior debt. As firms finance themselves with more senior debt, the expected recovery rate of both classes of creditor falls. Loans respond to an increase in recovery risk by increasing covenant protections while bonds demand higher credit spreads. This chapter shows that in a subordinated debt setting, debt contracting does not happen in a vacuum but depends on the protections and composition of adjacent debt contracts. In the second chapter, I use an adjusted structural model of subordinated default in the spirit of Merton (1974) to show that the debt capital structure of the firm is an important driver of relative protections between creditors. An important assumption in this model is the assumption of higher expected recovery rates for the senior creditor. This assumption is consistent with bank lenders' documented revealed preference for the recovery of principal over interest payments and this is what generates the increased covenant sensitivity of senior creditors that I also document in the data. In this model, relative covenant demand is only sensitive to changes in debt capital structure, not distance-to-default. This chapter shows that the specific mix of debt a firm uses to finance itself turns out to be an extremely relevant factor in the way it chooses to contract as well. In the third chapter, I use a novel source of data on the contracts of lending originations as well as their renegotiations to examine the role that affirmative covenants play in corporate debt contracts. From the data on originations, I conclude that affirmative covenants constitute a monitoring technology that banks use to keep tabs on their borrowers. Compared to negative covenants which are assumed to be a form of tripwire for lenders, affirmative covenants can be conceptualized as setting the sensitivity of these negative covenant tripwires. Using these observations, I form a working theory that banks monitor loans on an `information-first' basis, first asking for additional information before imposing more restrictions on firm actions. I test this in a sample of lending renegotiations and find that affirmative covenants are renegotiated first in time, first in default and first after technical defaults which are waived. The results suggest that affirmative covenants are a monitoring tool which is frequently adjusted to help banks manage the information asymmetry that develops over the life of a loan.
Fortney, Steven Michael, "Three Essays on the Financial Contracting of Corporate Debt" (2021). Yale Graduate School of Arts and Sciences Dissertations. 46.