Associate Professor and Director of the Accounting Ph.D. Program, Ed Owens, was recently accepted for publication by The Accounting Review. His paper is titled, “Lender Capital Management and Financial Covenant Strictness”.
The study provides evidence that lenders with lower regulatory capital issue loans with lower financial covenant strictness, consistent with such lenders viewing borrower covenant violations as costlier. This is because a borrower covenant violation may lead the lender to downgrade the loan, which triggers accounting that further reduces regulatory capital. Because of regulatory scrutiny, this is true even if the lender waives the violation. They find that this association is concentrated in performance covenants rather than capital covenants. They also find that lenders with relatively low capital issue loans with lower amounts and shorter maturities, consistent with such lenders replacing covenant protection with stricter loan terms on other dimensions. Finally, They find that this form of lender capital management extends to loan syndicate participant lenders, in that participants with relatively low capital adequacy take smaller loan shares when the lead arranger sets high covenant strictness.
Congratulations to Professor Owens on this impressive accomplishment.