Review of Accounting Studies

, Volume 20, Issue 4, pp 1596–1637 | Cite as

Default clauses in debt contracts

  • Ningzhong Li
  • Yun Lou
  • Florin P. VasvariEmail author


We examine the determinants of events of default clauses in syndicated loan and bond contracts, provisions that allow lenders to request the repayment of principal and to terminate lending commitments. We document significant variation in the use of default clauses and their restrictiveness within the same type of lending contract but also across loans and bonds. We find that default clauses in public bond contracts are less restrictive than those in syndicated loan contracts. We also document that two ex ante proxies for bankruptcy costs, the level of intangible assets and capitalized research and development expenditures at the time of debt contracting, are associated with less restrictive default clauses, especially in bond contracts. We conclude that bondholders attempt to mitigate the occurrence of inefficient defaults. Given their inability to coordinate with each other and their ownership of subordinated claims, bondholders incur higher default costs than bank lenders.


Events of default Default clauses Loan contracts Bond contracts Cross-default 

JEL Classification

G21 G33 M41 



We thank an anonymous referee, Anne Beatty (discussant), Hans Christensen (discussant), Brandon Julio, Laurence van Lent, Stan Markov, Stephen Penman (editor), K. Ramesh, participants at the 2012 FARS Meetings, 2013 AAA Annual Meetings and seminar participants at Bocconi University, Erasmus University, ESSEC, HEC Paris, London Business School, Rice University, the University of New South Wales, and the University of Texas at Dallas for valuable comments and suggestions. We gratefully acknowledge the financial support of the AXA Research Fund and the London Business School RAMD Fund. We also thank Giulia Pizzini, Surabhi Rajagopal, and Sundipika Wahal for excellent research assistance.


  1. Aghion, P., & Bolton, P. (1992). An incomplete contracts approach to financial contracting. Review of Economic Studies, 59(3), 473–494.CrossRefGoogle Scholar
  2. Alderson, M. J., & Betker, B. L. (1996). Liquidation costs and accounting data. Financial Management, 25(2), 25–36.CrossRefGoogle Scholar
  3. Amir, E., Lev, B., & Sougiannis, T. (2003). Do financial analysts get intangibles? European Accounting Review, 12(4), 635–659.CrossRefGoogle Scholar
  4. Armstrong, C. S., Jagolinzer, A. D., & Larcker, D. F. (2010). Chief executive officer equity incentives and accounting irregularities. Journal of Accounting Research, 48, 225–271.CrossRefGoogle Scholar
  5. Asquith, P., Gertner, R., & Scharfstein, D. (1994). Anatomy of financial distress: An examination of junk-bond issuers. The Quarterly Journal of Economics, 109(3), 625–658.CrossRefGoogle Scholar
  6. Ayotte, K., & Morrison, E. (2009). Creditor control and conflict in Chapter 11. Journal of Legal Analysis, 1(2), 511–551.CrossRefGoogle Scholar
  7. Beatty, A., Liao, S., & Weber, J. (2012). Evidence on the determinants and economic consequences of delegated monitoring. Journal of Accounting and Economics, 53, 555–576.CrossRefGoogle Scholar
  8. Becker, B., & Stromberg, P. (2012). Fiduciary duties and equity—Debtholder conflicts. Review of Financial Studies, 25(6), 1931–1969.CrossRefGoogle Scholar
  9. Bergman, Y. A., & Callen, J. L. (1991). Opportunistic underinvestment in debt renegotiation and capital structure. Journal of Financial Economics, 29, 137–171.CrossRefGoogle Scholar
  10. Bharath, S., Sunder, J., & Sunder, S. (2008). Accounting quality and debt contracting. The Accounting Review, 83(1), 1–28.CrossRefGoogle Scholar
  11. Billett, M., King, T., & Mauer, D. (2004). Bondholder wealth effects in mergers and acquisitions: New evidence from 1980s and 1990s. Journal of Finance, 59, 107–135.CrossRefGoogle Scholar
  12. Bolton, P., & Scharfstein, D. S. (1996). Optimal debt structure and the number of creditors. Journal of Political Economy, 104, 1–25.CrossRefGoogle Scholar
  13. Bradley, M., & Roberts, M. R. (2004). The structure and pricing of corporate debt covenants. Working paper, Duke University and University of Pennsylvania.
  14. Branch, B. (2000). Fiduciary duty: Shareholders versus creditors. Financial Practice and Education, 10(2), 8–13.Google Scholar
  15. Bris, A., & Welch, I. (2005). The optimal concentration of creditors. Journal of Finance, 60(5), 2193–2212.CrossRefGoogle Scholar
  16. Bris, A., Welch, I., & Zhu, N. (2006). The costs of bankruptcy: Chapter 7 liquidation versus Chapter 11 reorganization. Journal of Finance, 61(3), 1253–1303.CrossRefGoogle Scholar
  17. Campbell, T., & Kracaw, W. (1980). Information production, market signaling, and the theory of financial intermediation. Journal of Finance, 35(4), 863–882.CrossRefGoogle Scholar
  18. Choi, A., & Triantis, G. (2013). Market conditions and contract design: Variations in debt covenants and collateral. Working paper, NYU Law School.
  19. Christensen, H., & Nikolaev, V. (2012). Capital versus performance covenants in debt contracts. Journal of Accounting Research, 50, 75–116.CrossRefGoogle Scholar
  20. Collin-Dufresne, P., Goldstein, R. S., & Martin, J. S. (2001). The determinants of credit spread changes. Journal of Finance, 56(6), 2177–2207.CrossRefGoogle Scholar
  21. Dahiya, S., John, K., Puri, M., & Ramirez, G. (2003). Debtor-in-possession financing and bankruptcy resolution: Empirical evidence. Journal of Financial Economics, 69, 259–280.CrossRefGoogle Scholar
  22. De Franco, G., Vasvari, F., Vyas, D., & Wittenberg-Moerman, R. (2014). Sticky covenants. Working paper, University of Toronto, London Business School, and University of Chicago.
  23. Dechow, P. M., Sloan, R., & Sweeney, A. (1995). Detecting earnings management. The Accounting Review, 70(2), 193–225.Google Scholar
  24. Denis, D., & Mihov, V. (2003). The choice among bank debt, non-bank private debt, and public debt: Evidence from new corporate borrowings. Journal of Financial Economics, 70, 3–28.CrossRefGoogle Scholar
  25. Dewatripont, M., & Tirole, J. (1994). A theory of debt and equity: Diversity of securities and manager–shareholder congruence. Quarterly Journal of Economics, 109(4), 1027–1054.zbMATHCrossRefGoogle Scholar
  26. Diamond, D. (1984). Financial intermediation and delegated monitoring. Review of Economic Studies, 52, 393–414.MathSciNetCrossRefGoogle Scholar
  27. Emery, K., & Cantor, R. (2005). Relative default rates on corporate loans and bonds. Journal of Banking & Finance, 29(6), 1575–1584.CrossRefGoogle Scholar
  28. Fama, E. (1985). What’s different about banks? Journal of Monetary Economics, 15, 29–39.CrossRefGoogle Scholar
  29. Franks, J., & Torous, W. (1994). A comparison of financial recontracting in distressed exchanges and Chapter 11 reorganizations. Journal of Financial Economics, 35(3), 349–370.CrossRefGoogle Scholar
  30. Gilson, S. (1997). Transactions costs and capital structure choice: Evidence from financially distressed firms. Journal of Finance, 52, 161–196.CrossRefGoogle Scholar
  31. Gilson, S. C., John, K., & Lang, L. H. P. (1990). Troubled debt restructurings: An empirical study of private reorganization of firms in default. Journal of Financial Economics, 27, 315–353.CrossRefGoogle Scholar
  32. Greenwood, R., Hanson, S., & Stein, J. C. (2010). A gap-filling theory of corporate debt maturity choice. Journal of Finance, 65(3), 993–1028.CrossRefGoogle Scholar
  33. Grossman, R. J., Brennan, W. T., & Wento, J. (1997). Syndicated bank loan recovery study. Structured Finance Credit Facilities Report, Fitch IBCA, October 22. Google Scholar
  34. Grossman, S., & Hart, O. (1986). The costs and benefits of ownership: A theory of vertical and lateral integration. Journal of Political Economy, 94, 691–719.CrossRefGoogle Scholar
  35. Hadlock, C. J., & James, C. M. (2002). Do banks provide financial slack? Journal of Finance, 57(3), 1383–1419.CrossRefGoogle Scholar
  36. Hart, O., & Moore, J. (1988). Incomplete contracts and renegotiation. Econometrica, 56, 755–785.zbMATHMathSciNetCrossRefGoogle Scholar
  37. Hotchkiss, E., & Mooradian, R. (1997). Vulture investors and the market for control of distressed firms. Journal of Financial Economics, 32, 401–432.CrossRefGoogle Scholar
  38. Houston, J., & James, C. (1996). Bank information monopolies and the mix of private and public debt claims. Journal of Finance, 51, 1863–1889.CrossRefGoogle Scholar
  39. Ivashina, V., Iverson, B. C., & Smith, D. C. (2013). The ownership and trading of debt claims in Chapter 11 restructurings. Working paper, Harvard University, Northwestern University, and University of Virginia.
  40. Jiang, W., Li, K., & Wang, W. (2012). Hedge funds and Chapter 11. Journal of Finance, 67(2), 513–559.CrossRefGoogle Scholar
  41. John, T. A. (1993). Accounting measures of corporate liquidity, leverage, and costs of financial distress. Financial Management, 22(3), 91–100.CrossRefGoogle Scholar
  42. Kahan, M., & Klausner, M. (1997). Standardization and innovation in corporate contracting (or “The economics of boilerplate”). Virginia Law Review, 83, 713–771.CrossRefGoogle Scholar
  43. Krishnaswami, S., Spindt, P. A., & Subramaniam, V. (1999). Information asymmetry, monitoring, and the placement structure of corporate debt. Journal of Financial Economics, 51, 407–434.CrossRefGoogle Scholar
  44. McGlaun, G. (2007). Lender control in Chapter 11: Empirical evidence. Working paper, University of Rochester.
  45. Moody’s Investors Service. (2010). A user’s guide to Moody’s covenant quality snapshots. New York: Moody’s Investors Service.Google Scholar
  46. Nash, C. R., Netter, J. M., & Poulsen, A. B. (2003). Determinants of contractual relations between shareholders and bondholders: Investment opportunities and restrictive covenants. Journal of Corporate Finance, 9, 201–232.CrossRefGoogle Scholar
  47. Nini, G., Smith, D. C., & Sufi, A. (2009). Creditor control rights and firm investment policy. Journal of Financial Economics, 92, 400–420.CrossRefGoogle Scholar
  48. Ohlson, J. A. (1980). Financial ratios and the probabilistic prediction of bankruptcy. Journal of Accounting Reseach, 18, 109–131.CrossRefGoogle Scholar
  49. Rajan, R. G. (1992). Insiders and outsiders: The choice between informed and arm’s-length debt. Journal of Finance, 47(4), 1367–1400.CrossRefGoogle Scholar
  50. Rajan, R. G., & Zingales, L. (1995). What do we know about capital structure? Some evidence from international data. Journal of Finance, 50(5), 1421–1460.CrossRefGoogle Scholar
  51. Ramakrishnan, R., & Thakor, A. (1984). Information reliability and a theory of financial intermediation. Review of Economic Studies, 52, 415–432.MathSciNetCrossRefGoogle Scholar
  52. Roberts, M. R. (2014). The role of dynamic renegotiation and asymmetric information in financial contracting. Journal of Financial Economics, 116, 61–81.CrossRefGoogle Scholar
  53. Weiss, L. A. (1990). Bankruptcy resolution: Direct costs and violation of priority of claims. Journal of Financial Economics, 27, 285–314.CrossRefGoogle Scholar
  54. Wight, R., Cooke, W., & Gray, R. (2009). The LSTA’s complete credit agreement guide. New York: McGraw-Hill.Google Scholar

Copyright information

© Springer Science+Business Media New York 2015

Authors and Affiliations

  1. 1.University of Texas at DallasRichardsonUSA
  2. 2.HEC ParisJouy-en-JosasFrance
  3. 3.London Business SchoolLondonUK

Personalised recommendations