Performance Measures in Earnings-Based Financial Covenants in Debt Contracts

Li, Ningzhong

doi:10.2139/ssrn.1966112

Cited by 31 publications

(45 citation statements)

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“…Manso et al (2010) and Demiroglu and James (2010) show that strong borrowers signal their "good type" to lenders by committing to performance pricing provisions (PPP thereafter) and the tight slack in financial covenants at loan initiation, respectively. However, borrowers with inferior financial performance but Contents lists available at ScienceDirect journal homepage: www.elsevier.com/locate/jae promising future prospects often access debt markets.…”

Section: Introductionmentioning

confidence: 99%

Dynamic threshold values in earnings-based covenants

Vasvari

Wittenberg-Moerman

2016

Journal of Accounting and Economics

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Section: Introductionmentioning

confidence: 99%

Dynamic threshold values in earnings-based covenants

Vasvari

Wittenberg-Moerman

2016

Journal of Accounting and Economics

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“…Some studies found that EBITDA may be less useful in measuring credit risk than income before extraordinary items and operating profit (Li, 2016). The other studies found that firms near thresholds of EBITDA-based ratios are more likely to reduce R&D and SG&A expenditures (boosting EBITDA) prior to bond issuance (Begley, 2013).…”

Section: Literature Reviewmentioning

confidence: 99%

“…This is because of the omission of changes in working capital, which may drain cash seriously, while not being taken into account by EBITDA (Fridson and Alvarez, 2002). Despite all these drawbacks, EBITDA is used much more frequently, as compared to cash flows, as a performance measure in debt covenants measurement (Li, 2016;Demiroglu and James, 2010).…”

Section: Literature Reviewmentioning

confidence: 99%

EBITDA vs. Cash Flows in Bankruptcy Prediction on the Polish Capital Market

Welc¹

2017

EFAJ

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Abstract:One of the elements of company's evaluation is an analysis of bankruptcy risk metrics. In this study, the accuracy of bankruptcy predictions generated by EBITDA-based and cash flow-based liabilities-coverage ratios is evaluated within a sample of data from the Polish market. The study is based on a sample of 92 companies, in which case a bankruptcy filing was announced in a period between the beginning of 2009 and the end of the first half of 2016. The statistical analysis has confirmed the usefulness of the investigated liabilities-coverage ratios. Even though the sample covers wide variety of businesses, the logit models with only one ratio used as an explanatory variable are capable of identifying bankrupt firms (with one-period-ahead forecast horizon) in about 66-76% of cases. However, this research has not confirmed the supremacy of operating cash flows over EBITDA in predicting financial distress.

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“…In other words, the borrower will be able to scale up debt in good states, whereas the lender will quickly gain control rights when the borrower's performance deteriorates. Moreover, these covenants rarely include investment restrictions (Li 2015). 23 The most frequent income statement covenants are the following.…”

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confidence: 99%

“…23 Li (2015) suggests that contracting parties demand a performance measure that is invariant to the firm's investment activities, which can be controlled through other contractual mechanisms like restrictions on capital expenditure. 24 The calculation of the fixed-charge coverage ratio covenant can sometimes include restrictions that limit capital expenditures and/or dividend payments.…”

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confidence: 99%

Renegotiation and the Choice of Covenants in Debt Contracts

Saavedra

2015

SSRN Journal

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I investigate whether and how expected future contract renegotiation considerations affect the type of covenants used in ex-ante debt contracts. I find that when future contract renegotiation costs are expected to be high, debt contracts are less likely to include covenants that restrict the borrower's financial flexibility in good states. This finding suggests that when renegotiation costs are high, borrowers and lenders avoid the use of covenants that are more likely to hold up the borrower and force it to bypass valueenhancing corporate policies (e.g., investments). Consistent with this interpretation, the negative relationship between renegotiation costs and the presence of flexibility-reducing covenants becomes stronger when the borrower has fewer outside options and financial flexibility becomes more valuable. Finally, I find that when future renegotiation costs are expected to be high, debt contracts have more covenants that are directly linked to the current performance of the borrower, which allows for a more efficient allocation of decision rights between the borrower and lenders. Overall, this study provides initial evidence about how renegotiation considerations affect the design of covenant packages in debt contracts.

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Performance Measures in Earnings-Based Financial Covenants in Debt Contracts

Cited by 31 publications

References 50 publications

Dynamic threshold values in earnings-based covenants

Dynamic threshold values in earnings-based covenants

EBITDA vs. Cash Flows in Bankruptcy Prediction on the Polish Capital Market

Renegotiation and the Choice of Covenants in Debt Contracts

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