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Estimating the Benefits of Contractual Completeness

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  • Gregor Matvos
Abstract
I provide a revealed-preference-based framework that uses covenant prices and choices to quantitatively study how covenants generate firm benefits by completing debt contracts. I use a rational-expectations-based panel estimator of covenant prices, which does not require quasi-experimental variation, to circumvent the problem of endogenous covenant choices. I find that firms' surpluses exceed the spread paid on a loan. Leverage and interest-rate covenants produce the largest benefits, lending quantitative credence to several standard theories of covenants. Once covenants are chosen, the benefits from fine-tuning them are small, thus rationalizing "boilerplate" covenants. I conclude by discussing the extensions and limitations of my method. The Author 2013. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.

Suggested Citation

  • Gregor Matvos, 2013. "Estimating the Benefits of Contractual Completeness," The Review of Financial Studies, Society for Financial Studies, vol. 26(11), pages 2798-2844.
    • Handle: RePEc:oup:rfinst:v:26:y:2013:i:11:p:2798-2844
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    File URL: http://hdl.handle.net/10.1093/rfs/hht060
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    3. Miroslav Gabrovski & Ioannis Kospentaris & Lucie Lebeau, 2024. "The Macroeconomics of Labor, Credit and Financial Market Imperfections," Working Papers 2409, Federal Reserve Bank of Dallas.
    4. Eduardo Dávila, 2020. "Using Elasticities to Derive Optimal Bankruptcy Exemptions," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 87(2), pages 870-913.
    5. Jason Donaldson & Denis Gromb & Giorgia Piacentino, 2019. "Conflicting Priorities: A Theory of Covenants and Collateral," 2019 Meeting Papers 157, Society for Economic Dynamics.
    6. Xu Chong Bo & Wenyi Li & Jing Shi & Yi Zheng & Qing Zhou, 2021. "Relationship lending and bank loan covenant violations," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 61(4), pages 5847-5878, December.
    7. Amir Kermani & Yueran Ma, 2020. "Two Tales of Debt," NBER Working Papers 27641, National Bureau of Economic Research, Inc.
    8. Luca Benzoni & Lorenzo Garlappi & Robert Goldstein, 2023. "Incomplete Information, Debt Issuance, and the Term Structure of Credit Spreads," Management Science, INFORMS, vol. 69(7), pages 4331-4352, July.
    9. Green, Daniel & Liu, Ernest, 2021. "A dynamic theory of multiple borrowing," Journal of Financial Economics, Elsevier, vol. 139(2), pages 389-404.
    10. Kang, Ya & Li, Oliver Zhen & Lin, Yupeng, 2021. "Tax incidence in loan pricing," Journal of Accounting and Economics, Elsevier, vol. 72(1).
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    12. Francesco D'Acunto & Jin Xie & Jiaquan Yao, 2020. "Trust and Contracts: Empirical Evidence," CESifo Working Paper Series 8714, CESifo.

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