How Does Financing Impact Investment? The Role of Debt Covenants




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    • Chava is at the Mays Business School, Texas A&M University. Roberts is at The Wharton School, University of Pennsylvania. This paper previously circulated under the title, “Is Financial Contracting Costly? An Empirical Analysis of Debt Covenants and Corporate Investment.” We are especially grateful to the editors, Campbell Harvey and John Graham, and two anonymous referees for helpful comments. We also thank Andy Abel, Philip Bond, Doug Diamond, Itay Goldstein, Joao Gomes, Christopher Hennessy, Wei Jiang, Marcel Kahan, Michael Klausner, Michael Lemmon, Andrew Metrick, Vinay Nair, Stavros Panageas, Josh Rauh, David Scharfstein, Nicholas Souleles, Jeremy Stein, Amir Sufi, Toni Whited, Amir Yaron, Bilge Yilmaz, Moto Yogo, Luigi Zingales, Jeffrey Zwiebel and participants at the 2006 PENN/NYU Law and Finance Conference, 2006 Olin Corporate Finance Conference, 2006 NYU/New York Federal Reserve Joint Conference on Financial Intermediation, 2007 American Finance Association Meeting, 2007 Stanford Institute of Theoretical Economics, and Wharton Macro Lunch seminar for helpful discussions. Roberts gratefully acknowledges financial support from the Rodney L. White Center and an NYSE Fellowship.


We identify a specific channel (debt covenants) and the corresponding mechanism (transfer of control rights) through which financing frictions impact corporate investment. Using a regression discontinuity design, we show that capital investment declines sharply following a financial covenant violation, when creditors use the threat of accelerating the loan to intervene in management. Further, the reduction in investment is concentrated in situations in which agency and information problems are relatively more severe, highlighting how the state-contingent allocation of control rights can help mitigate investment distortions arising from financing frictions.