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Debt Covenant Renegotiations and Creditor Control Rights

Using a large sample of private debt renegotiations from 1996 to 2011, we report that, even in the absence of any covenant violation, debt covenants are frequently renegotiated. These renegotiations primarily relax existing restrictions and result in economically large changes in existing limits. Renegotiations of specific covenants are a response to both the distance the covenant variable is from its contractual limit and the firm׳s specific operating conditions and prospects. Moreover, the borrower׳s post-renegotiation investment and financial policies are strongly associated with the covenant changes resulting from the renegotiation. Overall, the findings imply that, even outside of default states, creditors have strong control rights over the borrower׳s operating and financial policies, and they exercise these rights in a state contingent manner through covenant renegotiations.