The Journal of Finance· 2025Q1
Losing Control? The Two‐Decade Decline in Loan Covenant Violations
- 40citations
- Q1SCImago
- 2025year
Short summary
The proportion of U.S. public firms reporting financial covenant violations dropped ~70% from 1997-2019, driven by lenders prioritizing fewer inconsequential violations over early detection of distressed borrowers.
AI-generated from the title and abstract; the full text is not read.
Key points
- Financial covenant violations by U.S. public firms fell ~70% between 1997 and 2019.
- A new model explains this by lenders trading early detection of distress for fewer inconsequential violations.
- The decline is linked to a changing composition of public borrowers.
- Heightened investor sentiment in the 2010s also contributed to the trend.
AI-generated from the title and abstract; the full text is not read.
Abstract
ABSTRACT The annual proportion of U.S. public firms that reported a financial covenant violation fell roughly 70% between 1997 and 2019. To understand this trend, we develop an estimable model of covenant design that depends on the ability to differentiate between distressed and nondistressed borrowers and the relative costs associated with screening incorrectly. We find that the drop in violations is best explained by an increased willingness to forgo early detection of distressed borrowers in exchange for fewer inconsequential violations, which we attribute largely to a shift in the composition of public borrowers and partly to heightened investor sentiment during the 2010s.
The authors' abstract, as published at the source. The Journal of Finance, 2025 · DOI ↗
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