Growth Opportunities and the Choice of Leverage, Debt Maturity, and Covenants

Authors

  • MATTHEW T. BILLETT,

  • TAO-HSIEN DOLLY KING,

  • DAVID C. MAUER

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    • Billett is at the University of Iowa, King is at the University of North Carolina at Charlotte, and Mauer is at Southern Methodist University. The authors thank Louis Ederington, Chitru Fernando, Bill Kinney, Scott Linn, Bill Megginson, Vassil Mihov, Sheridan Titman, seminar participants at the University of Oklahoma, University of Texas at Austin, and Texas Christian University, an anonymous associate editor, and especially an anonymous referee for many helpful comments and suggestions.

ABSTRACT

We investigate the effect of growth opportunities in a firm's investment opportunity set on its joint choice of leverage, debt maturity, and covenants. Using a database that contains detailed debt covenant information, we provide large-sample evidence of the incidence of covenants in public debt and construct firm-level indices of bondholder covenant protection. We find that covenant protection is increasing in growth opportunities, debt maturity, and leverage. We also document that the negative relation between leverage and growth opportunities is significantly attenuated by covenant protection, suggesting that covenants can mitigate the agency costs of debt for high growth firms.

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