Abstract
The thesis addresses the issue of verifiability in debt covenants, with the aim of extending our understanding of clauses and covenants that lenders incorporate into debt contracts to protect their interests. It consists of three essays presented as separate chapters.The first essay (Chapter 2 in this thesis) examines how debt contracting design is affected by fair value accounting, through modification of covenant definitions in private debt contracts. Fair value accounting has come under fire for being unsuitable for contracting both in the measurement of assets and liabilities. In the US lenders have been found to remove fair value measurements via clauses that exclude the effects of certain accounting standards (i.e., SFAS 159/ASC 825). We refer to these clauses fair value exclusion clauses (FVCs). We examine the incidence of FVCs in private lending agreements after the introduction of SFAS 159 and use an independently collected sample to replicate the results of prior research over an extended time period. We find that FVCs are significantly more prevalent than prior research indicates. Our results also suggest that fair value exclusions are positively associated with agency problems in fair value accounting, but negatively associated with benefits attributed to fair value accounting. Additional analysis suggests that lenders are more concerned about the effects of fair value estimates on earnings rather than the quantity of unreliable fair value estimates. Despite widespread concern that a lack of reliability makes fair value accounting problematic for contracting, our results indicate that lenders often find it useful, even when borrowers have only level three inputs in their fair value figures.
The second essay (i.e., Chapter 3) studies the extent to which lenders monitor corporate environmental compliance by studying environmental covenants in private lending agreements. Lenders include such covenants via environmental law compliance clauses in the representation and warranties section of debt contracts. Lenders can also intensify environmental monitoring by increasing the number of environmental laws they require borrowers to comply with. Despite the widespread increase in attention to corporate environmental responsibilities in the last 20 years, we document a fall in both the number of contracts with environmental covenants and in environmental covenant intensity over time. In cross sectional analysis, we find evidence that environmental monitoring is associated with borrowers’ characteristics, including credit risk, collateral risk and environmental information asymmetries between lenders and borrowers.
The third essay (Chapter 4) explores the consequences of breaching environmental covenant thresholds using a novel dataset collected directly from companies’ regulatory disclosure. My findings suggest that borrowers who violate environmental laws when having debt contracts without an environmental covenant experience higher environmental intensity in their subsequent contracts; I also document that environmental covenant intensity decreases in subsequent contracts following a violation of current contracts’ environmental covenants. Furthermore, environmental covenant violations are not associated with changes in financial covenant intensity, nor the cost of debt, suggesting that lenders are not punishing borrowers who fall below a minimum level of environmental performance. Lastly, in terms of changes in corporate behaviour, I show that within four and eight quarters of environmental covenant violation, there is a positive change in borrower’s capital expenditure while controlling for CAPEX restrictions. This change in investment behaviour, which contrasts with prior research into breaches of financial covenants, is not observed for borrowers that breach federal environmental law but have debt contracts without environmental covenants. I interpret this finding as evidence that the contractual characteristics of debt are important in shaping companies’ environmental investment policy.
| Date of Award | 2 Dec 2021 |
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| Original language | English |
| Awarding Institution |
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| Supervisor | Mariano Scapin (Supervisor) & Mark A Clatworthy (Supervisor) |