Clone of How structured products distort equity volatilities and yields

Optimizing Covenant Compositions; A Multivariate Approach to Dissect the Effects of Multiple Covenants in Private Loan Agreements: Private loan agreements often include multiple covenants, yet the interactions between these covenants remain under-explored in the literature. Building on prior research focused on single-covenant loans, such as Nini et al. (2012), Murfin (2012), and Demerjian and Owens (2014), and employing a multi-threshold Regression Discontinuity Design (RDD) as used in Wong et al. (2013), this paper extends the analysis to loans featuring multiple covenants and investigates how their interplay shapes firm behavior.
The author introduces a novel slack variable by estimating the probability of covenant violation using a multivariate normal distribution. Regression Discontinuity is employed to analyze the intensity of the covenant slack and the significance of the identified violation thresholds. By integrating these results with individual covenant effects, the author offers insights into the optimal composition of covenant sets. The three highest-intensity covenant pairs—NetWorth/Leverage, Net Worth/ICR, and FCCR/ICR—have high incidence on outstanding loans, providing evidence of their impact and utility for the industry.
These findings have significant implications for lenders in structuring loan agreements, borrowers in negotiating covenant terms, and researchers interested in firm behavior under varying covenant constraints.