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The Rise of Covenant-Lite Bond Contracting

The Rise of Covenant-Lite Bond Contracting We investigate the trading and yield effects of covenant-lite (cov-lite) high-yield bond contracts, which have a restricted (lite) set of covenants. The excluded covenants often are those that use accounting performance measures. Although much research has focused on the potential benefits of accounting as a basis for debt contracting, little is known about settings where it may be optimal to exclude accounting performance statistics from public debt contracts. We find that cov-lite high-yield bonds have a higher trading turnover and lower yield spreads. Our findings provide empirical support for theory, which predicts, for optimal bond covenant design, that a trade-off between improving trading ease versus enhanced investor protection needs to be managed. These results enhance our understanding of the limits of accounting’s role in (bond) contracting design. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png "Journal of Accounting, Auditing & Finance" SAGE

The Rise of Covenant-Lite Bond Contracting

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References (54)

Publisher
SAGE
Copyright
© The Author(s) 2021
ISSN
0148-558X
eISSN
2160-4061
DOI
10.1177/0148558X20987384
Publisher site
See Article on Publisher Site

Abstract

We investigate the trading and yield effects of covenant-lite (cov-lite) high-yield bond contracts, which have a restricted (lite) set of covenants. The excluded covenants often are those that use accounting performance measures. Although much research has focused on the potential benefits of accounting as a basis for debt contracting, little is known about settings where it may be optimal to exclude accounting performance statistics from public debt contracts. We find that cov-lite high-yield bonds have a higher trading turnover and lower yield spreads. Our findings provide empirical support for theory, which predicts, for optimal bond covenant design, that a trade-off between improving trading ease versus enhanced investor protection needs to be managed. These results enhance our understanding of the limits of accounting’s role in (bond) contracting design.

Journal

"Journal of Accounting, Auditing & Finance"SAGE

Published: Jan 1, 2021

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