What's My Style? Supply‐Side Determinants of Debt Covenant Inclusion

Abstract

We examine the supply-side determinants of debt covenants included in loan agreements. Controlling for borrower characteristics, we find evidence that the covenants that lead arranger banks include in new contracts persist into future contracts for at least three years. We document that this covenant style effect is smaller when borrowers have recently violated a debt covenant or when the loan issue amount is large, and it is larger when the costs of contracting are highest and when a borrower provides collateral. We also find that the covenant style effect decreases following changes in a bank's CEO or CFO. Overall, our evidence is consistent with lenders’ covenant preferences arising from strategic cost-benefit analysis informed from prior lending experiences and being related to lender expertise in negotiating, monitoring, and enforcing covenants.