Debt Dispersion, Creditor Conflicts, and Covenants in Corporate Loans

Abstract

How do conflicts between different creditors affect debt contract terms? We study this question by examining the effect of dispersion in firms' existing debt structures on the use of covenants in new corporate loans. We find that more covenants are included when firms' existing debt is more dispersed. This effect is strongest for firms with high default risk and opaque accounting. Our findings suggests that covenants are not only used to address creditor-shareholder conflicts but also conflicts between creditors. Further, our results indicate a dynamic component missing from static debt structure models: Dispersion today entails constraints when issuing future debt.