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Contracting Costs, Covenant-Lite Lending, and Reputational Capital
Published online by Cambridge University Press: 07 August 2023
Abstract
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Using a large sample of leveraged loans, we provide evidence that, despite having fewer creditor control rights, covenant-lite (Cov-Lite) loans have similar recovery rates and significantly lower spreads than loans with maintenance covenants. We find that the propensity to borrow Cov-Lite is related to various proxies for the reputational capital of a borrowing firm’s private equity sponsor. We construct a simple model to illustrate the relationship between reputational capital, covenants, and loan spreads in the leveraged loan market. Our model illustrates how reputational capital can substitute for covenants in mitigating agency costs of debt, leading to lower loan spreads for Cov-Lite loans.
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- Research Article
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- Creative Commons
This is an Open Access article, distributed under the terms of the Creative Commons Attribution licence (http://creativecommons.org/licenses/by/4.0), which permits unrestricted re-use, distribution and reproduction, provided the original article is properly cited.- Copyright
- © The Author(s), 2023. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington
Footnotes
We thank Thierry Foucault (the editor), Boris Vallée (the referee), seminar participants at the Australian National University, Copenhagen Business School, University of Colorado Boulder, and conference participants at the 2020 FMA Annual Meeting for their helpful comments and suggestions. A prior version of this article was titled “Contracting Costs and Reputational Contracts.”
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