520005

The University of Chicago
The Booth School of Business of the University of Chicago

The University of Chicago Law School
State Laws and Debt Covenants

Author(s): YaxuanQi and JohnWald
Source: Journal of Law and Economics, Vol. 51, No. 1 (February 2008), pp. 179-207
Published by: The University of Chicago Press for The Booth School of Business of the University of
Chicago and The University of Chicago Law School
Stable URL: http://www.jstor.org/stable/10.1086/520005 .
Accessed: 01/07/2014 06:44
Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at .
http://www.jstor.org/page/info/about/policies/terms.jsp
.
JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of
content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms
of scholarship. For more information about JSTOR, please contact support@jstor.org.
The University of Chicago Press, The University of Chicago, The Booth School of Business of the University of
Chicago, The University of Chicago Law School are collaborating with JSTOR to digitize, preserve and extend
access to Journal of Law and Economics.
http://www.jstor.org
This content downloaded from 119.226.90.54 on Tue, 1 Jul 2014 06:44:42 AM

All use subject to JSTOR Terms and Conditions
State Laws and Debt Covenants

Yaxuan Qi Concordia University
John Wald University of Texas at San Antonio
Abstract
We examine whether state laws impact the use of debt covenants by using a
sample of U.S. public bond issues from 1987 to 2004. We consider variation
in state laws with respect to the minimum asset-to-debt ratio necessary for a
payout and with respect to antitakeover statutes. We find that firms incorporated
in states with stricter restrictions on distributions are less likely to include debt
covenants that constrain payouts, limit additional debt, or restrict the sale of
assets. Thus, state payout restrictions appear to be a substitute for the use of
these debt covenants. On the other hand, firms incorporated in states with
stronger antitakeover statutes are somewhat more likely to use debt covenants.
This finding is consistent with the notion that firms with antitakeover protection
are more likely to suffer from agency problems and, thus, are more likely to
use debt covenants to minimize agency costs.
1. Introduction
The Coase Theorem suggests that, in a world of rational agents and no transaction
costs, an optimal contract will be derived from free bargaining and, hence, that
the legal environment should function only to facilitate such contracts. Thus, if
transaction costs are low, highly restrictive laws could hinder the creation of an
optimal contract. Alternatively, if transaction costs are significant, corporate laws
could substitute for or complement the potentially costly negotiations inherent
in writing contracts.1
A variety of empirical research has suggested that legal systems have a significant impact on corporate policies. For instance, La Porta et al. (1997, 1998,
2000), Doidge, Karolyi, and Stultz (2007), and others have studied the influence
of legal protection on corporate ownership structures and corporate valuation
in an international context. In contrast, we examine the interaction between
creditors legal protection resulting from U.S. laws and the covenants in negoWe thank Mike Lockerbie for excellent research assistance and Dhammika Dharmapala, Michael
Long, Lucas Roth, and an anonymous referee for comments on earlier drafts of this paper.
1
Smith and Warner (1979) suggest that, although the negotiation of covenants can be costly, these
covenants can increase the value of a firm. See, for example, Cooter (1982) for a general discussion
of the Coase Theorem.
[Journal of Law and Economics, vol. 51 (February 2008)]
2008 by The University of Chicago. All rights reserved. 0022-2186/2008/5101-0007$10.00
179

180
The Journal of LAW & ECONOMICS
tiated debt agreements. Instead of looking at contract differences across countries,

we examine contract differences across states. By focusing only on U.S. firms,
we control for the general level of economic development, the function of capital
markets, and federal regulations, which are the same for all U.S. firms. We focus
our attention on two types of statutory restrictionsnamely, restrictions on the
minimum asset-to-debt ratio necessary to make a distribution and restrictions
on hostile takeovers. These two types of restrictions are designed to protect
creditors from expropriation by shareholders and are adopted widely in U.S.
debt agreements. We examine whether firms incorporated in states with stricter
statutory restrictions are more or less likely to use additional restrictions of either
the same type or other types in their debt covenants.
We find that firms incorporated in states with stricter restrictions regarding
payouts are less likely to add debt covenants that constrain distributions, limit
additional debt, or restrict the sale of assets. Thus, state payout restrictions appear
to substitute for the use of these bond covenants. Since these covenants are costly
to negotiate, firms have an incentive not to include them if state laws already
provide similar protection, which is consistent with the costly contracting hypothesis of Smith and Warner (1979). This finding suggests that state laws provide
sufficient protection for creditors with regard to some dimensions.
When examining antitakeover statutes, we find evidence that firms incorporated in states with greater antitakeover restrictions are more likely to include
additional covenants that limit hostile takeovers. This finding is consistent with
the notion that certain firms most at risk of a hostile takeover seek protection
both from state law and from debt covenants. The positive correlation between
antitakeover laws and event-risk covenants also may be due to entrenched managers more easily including debt covenants that further consolidate their positions.2
We also find some evidence of cross effects. Specifically, firms incorporated
in states with stricter statutory payout restrictions are less likely to include other
types of covenants, such as event-risk or asset-substitution restrictions. Thus,
these state laws may provide some protection from other types of firms actions
that could decrease bond value. In addition, firms incorporated in states with
strong antitakeover protection are more likely to use some payout, financing, or
asset-substitution restrictions. Incorporation in a state with more antitakeover
provisions is regarded as a measure of weak governance because these protections
isolate managers from the pressures of financial markets (see, for example, Gompers, Ishii, and Metrick 2003). Therefore, antitakeover laws may indicate a greater
possibility of agency problems and, thus, more of a need for the use of covenants
to mitigate agency issues (see related discussions in Gompers and Lerner 1996;
Begley and Feltham 1999; Chava, Kumar, and Warga 2005). This finding is also
consistent with the notion that adding one type of covenant lowers the costs of
2
Kahan and Klausner (1993) argue that covenants that deter takeovers are used primarily to
entrench managers and not to benefit bondholders.

Debt Covenants
181
adding other covenants. Lehn and Poulsen (1991) show that debt issues that
include covenants regarding dividends or additional debt are more likely to
include event-risk protection. If there are fixed costs to adding covenants of any
type, a reduction in one type of covenant may imply a relatively higher cost of
including other covenants. Thus, a reduction in the use of one covenant because
of substitution with state payout restrictions would imply fewer other covenants,
whereas an increase in the use of one covenant that is complementary to antitakeover laws would imply more other covenants.
Our findings complement those of previous studies on the interaction between
the legal system and corporation policies. Statutory legal protections for investors
can function as either a substitute or a complement to contract-specific protections, depending on the impact of the legal system on the relative costs and
benefits of such additional contracts. For instance, using a large sample of firms
across 49 countries, La Porta et al. (1998) find a significant negative correlation
between the quality of investor legal protection and the concentration of ownership. Gore, Sachs, and Trzcinka (2004) examine whether public finance disclosures and bond insurance are substitutes. They find that, when disclosure is
required by state law, issuers use less insurance. Thus, legal protection and firmlevel adaptive mechanisms can work as substitutes. Consistent with these results,
we find that state laws that restrict payouts substitute for issue-specific covenants.
On the other hand, Doidge, Karolyi, and Stultz (2007) use a model of the interaction
between a countrys investor protection and firm-level governance mechanisms to
show that these elements function as complements in countries with low levels of
investor protection. Cumming and Johan (2006) examine covenants for international venture capital funds. They find that funds located in countries with better
developed legal systems are more likely to use additional covenants. Consistent
with these results, we find that state antitakeover laws appear to increase the need
(or managers ability) to add entrenching debt covenants.
A considerable portion of the prior literature examines which firms use covenants and how they function to increase a firms value (see Smith and Warner
1979; Malitz 1986; Asquith and Wizman 1990; Lehn and Poulsen 1991; Nash,
Netter, and Poulsen 2003). The more recent literature examines the degree to
which covenants are priced (see Bradley and Roberts 2004; Riesel 2004; Wei,
2005). In this paper, we instead focus on the relationship between state laws and
bond covenants, while controlling for the determinants of covenant choice suggested in the existing literature.
Section 2 discusses our hypotheses in greater detail. Section 3 details our data.
Section 4 presents our empirical results, and Section 5 summarizes our conclusions.
2. Discussion and Hypotheses
The conflict between shareholders and bondholders has been extensively studied in the finance literature (see, for example, Jensen and Meckling 1976; Myers

182
1977). Bond covenants provide one way to mitigate this conflict. As Smith and
Warner (1979) discuss, management can use bond covenants to bind themselves
from later expropriating creditors investments; covenant use can therefore lower
financing costs and increase firm value. The number and type of covenants
depend on the probability of expropriation (see, for instance, Malitz 1986), the
costs of the firms decreased flexibility (Nash, Netter, and Poulsen 2003), and
the costs of the negotiation of covenants. As we demonstrate, the use of covenants
also depends on state laws, which either may provide alternative mechanisms
for creditor protection or may increase the possibility of agency problems. We
focus our attention on two types of statutory restrictions: restrictions on the
minimum asset-to-debt ratio necessary to make a distribution to shareholders
and restrictions on hostile takeovers.
State laws differ in the degree to which they restrict payouts when debt is
present. A few states, most notably Delaware, provide few restrictions, allowing
payments to come from either surplus or net profits in a particular year. Firms
incorporated in New York, Texas, and many other states are subject to the net
worth or net value rulethat is, they cannot make distributions if the payout
would decrease the net value of assets below their stated capital, which effectively
is the book value of debt. Firms incorporated in California or Alaska are subject
to a more stringent test, with distributions allowed only if the net assets of the
corporation remain greater than 1.25 times its liabilities.3 Wald and Long (2007)
describe these laws and demonstrate how they impact firms choice of capital
structure, and Mansi, Maxwell, and Wald (2006) demonstrate that firms incorporated in states with stricter payout laws have significantly lower bond yields.
Mansi, Maxwell, and Wald suggest that, instead of corresponding with a race to
the top or a race to the bottom, variations in state payout laws may provide an
opportunity for firms with different contracting needs to maximize their value
by choosing the most appropriate legal environment.
Firms may face similar payout constraints from debt covenants written into
particular contracts. These covenants take a variety of forms, including dividendrelated payments, restricted payments, and subsidiary dividend-related payments
3
Specifically, New York law states, Dividends may be declared or paid and other distributions
may be made out of surplus only, so that the net assets of the corporation remaining after such
declaration, payment or distribution shall at least equal the amount of its stated capital; except that
a corporation engaged in the exploitation of natural resources or other wasting assets, including
patents, or formed primarily for the liquidation of specific assets, may declare and pay dividends or
make other distributions in excess of its surplus, computed after taking due account of depletion
and amortization, to the extent that the cost of the wasting or specific assets has been recovered by
depletion reserves, amortization or sale, if the net assets remaining after such dividends or distributions are sufficient to cover the liquidation preferences of shares having such preferences in
involuntary liquidation (New York CLS Business Corporations Code, sec. 510 [2003]). The more
restrictive California law states, The distribution may be made if immediately after giving effect
thereto: (1) The sum of the assets of the corporation (exclusive of goodwill, capitalized research and
development expenses and deferred charges) would be at least equal to 1 1/4 times its liabilities (not
including deferred taxes, deferred income and other deferred credits) (California Corporate Code,
sec. 166 [2004]).

Debt Covenants
183
covenants, which limit dividends, distributions, or dividends by subordinated

firms, respectively (see Table A1 for further description of commonly used covenants). As with state laws, firms typically avoid getting close to these constraints
in order to preserve their financial flexibility (Kalay 1982).4 Because restrictions
on distributions are typically a function of the firms capital structure, these
restrictions also limit the firms choice of capital structure (for a formal model,
see Smith and Warner 1979; Wald 1999). Thus, covenants that restrict firm
financing, such as an indebtedness covenant that limits additional debt either
in absolute dollar amounts or as a fraction of capital, may have an impact on
constraining firm behavior that is similar to the impact of payout restrictions.
The most frequently used covenants that restrict financing are the negativepledge, indebtedness, and subsidiary debt issuance covenants.
Antitakeover laws also vary between states, and managers of firms prefer to
reincorporate in states with more antitakeover provisions, which often is detrimental to shareholders (see Heron and Lewellen 1998; Bebchuk and Cohen
2003). Mansi, Maxwell, and Wald (2006) show that these antitakeover laws have
little effect on average bond yields. Thus, these laws do not compensate other
stakeholders of the firm, such as creditors, for the losses suffered by shareholders.
The primary laws that we consider are the same as those addressed by Bebchuk
and Cohen and include antigreenmail, control share, fair-price, freeze-out, poison
pill endorsement, and constituencies statutes.5
A parallel set of creditor or antitakeover protections is sometimes added to
specific debt covenants. The most frequently used antitakeover covenants are
the consolidation/merger covenant, which usually restricts some mergers, and
specific event-risk covenants, often called poison puts, which allow bondholders
to force repayment in the event of a hostile takeover.6 Kahan and Klausner (1993)
point out that these restrictions are more effective at preventing hostile takeovers
and, thus, at entrenching management than they are at protecting creditors.
Kahan and Klausner suggest that more effective event-risk protection for creditors
is offered by covenants that trigger puts in the event of a rating decline (rating
decline triggers put [RDTP] covenants). Although RDTP covenants are used
4
John and Kalay (1982) offer a model of optimal covenant choice.

We consider the antigreenmail laws of Ohio and Pennsylvania, which require unsuccessful acquirers to disgorge all profits on stock purchases. The control share statute requires a hostile bidder
to put an offer to a vote of shareholders early in the process. The fair-price statute requires a bidder
that gains control to pay remaining minority shareholders the same price that it paid for shares
acquired in the original bid. Freeze-out and business combination statutes restrict bidders from
merging assets for a specified number of years. Poison pill endorsements are rights that entitle existing
shareholders to significant value in the event of an acquisition without board approval. Constituencies
statutes allow managers to take into account the interests of nonshareholders when defending against
a takeover. See Bebchuk and Cohen (2003) or Gartman (2000) for additional details.
6
The consolidation/merger covenant typically requires that the surviving corporation assumes all
debts; thus, this covenant is not restrictive for most acquisitions. See Asquith and Wizman (1990)
or Lehn and Poulsen (1991) for a discussion. Event-risk covenants (or poison puts) allow creditors
to put the debt back to the issuer in the event of a change in control. See Lehn and Poulsen (1991)
for further details and for examples of such covenants.
5

184
rarely in practice, we also consider them in our analysis of antitakeover

restrictions.
We examine the degree to which state laws have an impact on the use of these
covenants in public bond issues. The costly contracting hypothesis of Smith and
Warner (1979) states that there exists a set of optimal contracts that maximizes
the value of a firm but that these contracts are costly to implement. These
contracting costs suggest a negative correlation between state-level restrictions
and the use of debt covenants. We consider the following null hypothesis:
Hypothesis 1. The payout restrictions of the firms state of incorporation are
not related to the use of payout or financing covenants.
Rejection of this hypothesis and the finding of a negative correlation would
indicate that payout restrictions in state laws substitute for debt covenant restrictions. This finding also implies that statutes provide effective protection for
creditors and that this protection is recognized by investors. Thus, reincorporation in another state must be too costly for the firm to be able to easily escape
from restrictive state statutes. Hypothesis 2 addresses the use of antitakeover
covenants.
Hypothesis 2. The antitakeover statutes of the firms state of incorporation
are not related to the use of antitakeover covenants.
Rejection of this hypothesis and the finding of a positive correlation would
suggest a number of possible alternatives. For instance, certain firms may particularly need protection from takeovers and will seek protection both from state
laws and from covenants. Alternatively, as Gompers, Ishii, and Metrick (2003)
suggest, if the use of antitakeover devices is a measure of poor governance, then
entrenched managers may be able to further consolidate their position by adding
covenants against takeovers.
In addition, we may find cross effects in state laws and debt covenants. Lehn
and Poulsen (1991) find that creditors who negotiate payout restrictions are
more likely to negotiate event-risk protection. This finding is consistent with
the existence of fixed costs for the negotiation of debt covenants; thus, once
some covenants are negotiated, additional covenants may be less expensive to
add. Therefore, if statutory payout restrictions substitute for payout or financing
covenants, they also may substitute for event-risk covenants. On the other hand,
if antitakeover statutes complement event-risk covenants, they also may complement payout or financing covenants. As proxies for poor governance, antitakeover statues may signal more agency problems and, therefore, may increase
the value of additional covenants, which would mitigate these agency costs.
3. Data
We gathered data on bond issues from Mergents Fixed Investment Securities
Database (FISD). The version of the FISD that we used includes U.S. public

Debt Covenants
185
debt issues through the second quarter of 2004. We excluded issues before 1987
because the constitutionality of antitakeover laws was clarified by the U.S. Supreme Court in that year (CTS Corp. v. Dynamics Corp. of America, 481 U.S. 69
[1987]). We restricted our sample to U.S. corporate debentures, insured corporate
debentures, and corporate zero-coupon bonds.7 We excluded Rule 144a issues
and medium-term notes because the covenant information for these issues usually is not present in the FISD. Following Billet, King, and Mauer (2007), we
excluded bonds for which both the subsequent and covenant data flags are
set to no, which indicates that the FISD does not provide covenant information
for this particular issue. In addition, we excluded issues for which the covenant
flag is marked as no covenants but for which some covenants are reported.8
Convertible debt issues also are excluded because the equity option causes these
instruments to be less comparable and because, as Kahan and Yermack (1998)
report, convertible bonds rarely include debt covenants.
As a control in our regressions, we included Standard & Poors Compustat
data on firm characteristics from the year prior to issuance date (after adjustment for differences in fiscal year end). We collected the most recent state-ofincorporation data from Compustat files; then, by searching the FISD, we checked
each firm to determine whether it had reincorporated during the time period
that we considered. After merging the Compustat and FISD data and deleting
observations for which state of incorporation could not be identified or firm
characteristics were missing, we obtained a sample of 5,514 debt issues by 1,444
firms.
To collect data on state laws, we used Lexis/Nexis to review state statutes for
payout restrictions, as did Wald and Long (2007). A payout restriction is defined
as the minimum asset-to-debt ratio necessary to make a distribution. This variable differs among states, from 0 for states such as Delaware, where payouts
can be taken from that years profits, to 1.25 for California and Alaska. We used
the antitakeover index discussed by Bebchuk and Cohen (2003),9 although we
added a recapture (antigreenmail) variable for firms incorporated in Ohio or
Pennsylvania after 1990. Thus, the index that we used varies from 0 to 6.10 In
addition, we checked the Investor Research Responsibility Center data to determine whether any of the firms in our sample had opted out of state antitakeover laws. The ability to opt out is limited to only a few states, so this factor
applies to a small fraction of the total sample.
We controlled for a number of issue and firm characteristics in our analysis.
The issue characteristics include the maturity of the security: we expect that debt
7
We also included corporate line-of-credit-backed bonds; however, none of these bonds appear
in our final sample after filtering.
8
Only a few such issues exist, and they include unusual features such as covenants that disappear
if the firm becomes investment grade.
9
Data on state antitakeover laws were collected from Lucian Arye Bebchuk, Data: Data on State
Antitakeover Index 19862001 (http://www.law.harvard.edu/faculty/bebchuk/data.shtml).
10
Separate consideration of antigreenmail laws has little impact on our results.

186
with longer maturity is more likely to include covenants because of the increased
opportunity for moral hazard problems. We also include a dummy variable for
whether the debt issue includes put or call features. Bodie and Taggart (1978)
discuss how call features may reduce managers agency problems and how a put
may substitute for bond covenants by allowing creditors to force a repurchase
in the event of contrary actions by management. Similarly, secured bonds may
not need additional bond covenants. Since these bond features may be seen as
outcomes of the same bargaining process that produces the choice of covenants,
we tested whether the inclusion of these features has a significant impact on our
other results and found that it does not.
The firm characteristics we consider include the debt-to-market-value ratio
as a measure of the firms riskiness. We also include a dummy variable for
whether the current debt is rated as high yield. In alternative regressions, we
consider the interest coverage ratio and the Altman Z-score as additional measures of the debts risk, but these control variables did not have an impact on
our primary results. As did Malitz (1986), we hypothesize that riskier firms are
more likely to use debt covenants. Also following Malitz, we use the size of the
current issue relative to the size of the firms total debt and a measure of the
firms size proxied by the log of book value. Malitz hypothesizes that if the issue
is large relative to the firms outstanding debt, it is more likely to be a new entry
in the public bond markets, and, thus, covenants may be required in order to
compensate for lower issuer reputation. Similarly, small firms may have a lower
reputation and, therefore, may require the use of covenants. Since the total
benefits of negotiated covenants may increase with the size of the issue, whereas
the costs may be fixed, we include the log of the issue amount as an additional
control variable. Nash, Netter, and Poulsen (2003) discuss how firms with greater
growth opportunities want to preserve their financial flexibility and avoid restrictive covenants. As in their analysis, we include variables for the firms marketto-book ratio and the ratio of research and development (R&D) to total assets.
In an alternative specification, we also include dummy variables for one- or
two-digit standard industrial classification (SIC) codes. The inclusion of these
dummy variables decreases the number of available observations in the probit
regressions, since certain dummy variables explain perfectly the use of certain
covenants (firms in certain industries either never or always use particular covenants). However, since the coefficients for state laws change little with the
addition of these dummy variables, we exclude them from our final specification.
Alternative specifications that exclude financial and regulated firms also provide
similar results.
We also control for general market condition. Lehn and Poulsen (1991) find
that the incidence of event-risk covenants increased after the wave of takeovers
in the 1980s. As a control variable for the amount of takeover activity, we
therefore include the log of the dollar value of mergers, from Thomson Financials
Securities Data Corportation database, in the firms industry (as assigned by the
one-digit SIC code) in the prior year. We include all mergers in which a U.S.

Debt Covenants
187
firm was the target and the acquisition value was at least $50 million. Similarly,
we control for the macroeconomic default risk by using the default rate for debt
in the prior year, as reported by Standard & Poors (19862003).
Wald and Long (2007) find that a firms decision about whether to incorporate
in the same state in which its headquarters is located is endogenously determined
along with its capital structure. However, since our analysis of the use of covenants is explicitly conditioned on a firms leverage, we find little evidence that
state self-selection has an impact on covenant choice.
4. Empirical Results
We begin by providing the frequencies of various covenants and summary
statistics for our control variables. We perform t-tests to determine whether
certain covenants are more frequently used by firms incorporated in states with
more restrictive payout restrictions. We use a probit regression to study whether
the debt issue includes any covenants, and we use a Poisson regression to study
the determinant of the total number of covenants. Since the determinants of
covenants may differ between covenants, these simple probit and Poisson regressions may be misspecified. We therefore consider separate probit regressions
for each of the more commonly used debt covenants. The dependent variable
in these probit regressions is a binary variable equal to one if a particular debt
covenant is used and zero otherwise. The independent variables are the statutory
restrictions in state laws and a set of control variables that include firm and
issue characteristics. We briefly contrast our results for the control variables with
the existing literature after our discussion of the interaction between state laws
and covenant choice. Since different bond issues from the same firm may be
more likely to have similar covenants, we adjust for heteroskedasticity by using
a White correction with clustering by firm in all regressions.
4.1. Summary Statistics
For our final sample, we consider 5,514 debt issues from 1987 to 2004 that
were from 1,444 firms. Table 1 presents summary statistics for the relevant
covenants considered in the FISD data. Overall, 96.2 percent of the issues in the
sample include some covenants. The most frequently included covenants are a
general (and relatively weak) consolidation/merger restriction and a restriction
on the sale of assets. Other frequently used covenants are the negative-pledge
covenant, defeasance with tax consequences covenant, defeasance without tax
consequences covenant, cross-acceleration covenant, sales leaseback restriction,
indebtedness restriction, and the restricted-payments covenant. A variety of covenants for subsidiary actions also appear with some frequency, including a covenant for subsidiary dividend-related payments and subsidiary indebtedness.
Restrictions on dividend payments and a net earnings test for additional issuance
appear less frequently, whereas other financing covenants are almost never used.
To limit the scope of the study to the most relevant covenants, we focus our

Table 1
Frequency of Covenant Use
Covenant
Any
Payout:
Restricted payments
Subsidiary dividend-related payments
Dividend-related payments
Financing:
Negative pledge
Cross acceleration
Subsidiary indebtedness
Indebtedness
Subsidiary stock issuance
Subsidiary preferred-stock issuance
Stock transfer, sale, or disposal
Subordinated debt issuance
Liens
Subsidiary liens
Cross default
Subsidiary-funded debt
Net earnings test for issuance
Stock issuance restriction
Senior debt issuance
Funded debt
Subsidiary fixed-charge coverage
Subsidiary borrowing restriction
Leverage test
Subsidiary leverage test
Event risk:
Consolidation/merger
Poison put
RDTP
Asset substitution:
Asset sales restriction
Sales leaseback restriction
Subsidiary sales leaseback restriction
Asset sales require redemption
Investments
Subsidiary investments
Subsidiary asset sales reduce debt
Other:
Defeasance with tax consequences
Defeasance without tax consequences
Transaction affiliates
Legal defeasance
Subsidiary guarantee
Subsidiary redesignation
Economic covenant defeasance
After acquired property clause
Maintenance net worth
Declining net worth
Fixed-charge coverage
%
.962
.210
.192
.039
.697
.527
.264
.253
.099
.096
.094
.064
.058
.050
.042
.026
.025
.020
.012
.011
.003
.003
.002
.002
.878
.232
.021
.875
.448
.417
.145
.019
.018
.008
.673
.619
.211
.108
.082
.067
.048
.023
.019
.015
.004
Note. Data are percentages of corporate debt issues that use a particular covenant
in a sample of nonconvertible bond issues from Mergents Fixed Investment Securities Database, 1987 to 2004. Of the sample of 5,514 debt issues, a total of 5,305
issues use some sort of covenant. RTDP p rating decline triggers put.

Debt Covenants
189
Table 2
Summary Statistics for Control Variables
Total covenants
Total asset constraint
Antitakeover index
Market
Log(issue amount)
Firm size
Leverage
Market-to-book ratio
R&D-to-assets ratio
Log(maturity)
High yield
Putable
Callable
Secured
Default ratet1 (%)
Log(mergerst1)
Mean
Median
SD
25th
Percentile
75th
Percentile
7.722
.407
2.146
.407
5.260
8.750
.400
1.197
.009
2.260
.718
.030
.568
.049
1.818
10.705
7.000
.000
1.000
.124
5.298
8.687
.366
.966
.000
2.301
1.000
.000
1.000
.000
1.410
10.777
4.630
.493
1.667
1.158
1.334
1.919
.238
.942
.023
.695
.450
.170
.495
.217
1.120
1.365
5.000
.000
1.000
.043
4.828
7.430
.211
.728
.000
1.935
.000
.000
.000
.000
.600
9.914
9.000
1.000
4.000
.323
5.784
9.928
.559
1.388
.002
2.483
1.000
.000
1.000
.000
2.590
11.715
Note. For all variables listed, data are based on 5,514 debt issues by 1,444 firms. Total asset constraint is
the minimum asset-to-debt ratio required for a distribution to shareholders, given the firms state of
incorporation. The antitakeover index gives the number of antitakeover statutes, given the firms state of
incorporation (as in Bebchuk and Cohen 2003), plus 1.0 if antigreenmail laws are in effect (that is, if the
firm is incorporated in Pennsylvania or Ohio, which have a recapture or disgorgement statute in effect
after 1990). Market is the size of the issue relative to the firms total debt. Log(issue amount) measures
the size of the issue in millions of dollars. Firm size equals the log of the firms total assets. Leverage is
the firms debt divided by total market value at the year of issuance. Market-to-book ratio is the sum of
the market value of the firms equity plus the sum of the book value of the firms debt and preferred stock,
all divided by total assets. The R&D-to-assets ratio equals the firms research and development expenses
divided by total assets or zero if R&D is missing. Maturity is the number of years to maturity of the issue.
High yield equals one if the issue is rated less than BAA by Moodys. Putable equals one if the issue includes
a put, and callable equals one if the issue includes a call. Secured equals one if the debt is senior secured
and zero otherwise. The default rate is for all bonds rated by Standard & Poors in the prior year, and
log(mergerst1) is the log of the market value of mergers in the corresponding one-digit standard industrial
classification code in the prior year.
analysis on those covenants closely related to payouts, financing, mergers, or

asset substitution and with a frequency of at least 10 percent in the data (although
we also consider the infrequently used RDTP covenant).
As shown in Table 2, the mean number of covenants used is 7.72 (median of
7.0 and maximum of 28). As Figure 1 demonstrates, the mean number of covenants varies widely across years.11 Firms in the sample issue public debt and,
therefore, have a higher leverage ratio, at 40.0 percent for debt/value, than most
U.S. firms. Approximately one-half of larger U.S. public firms are incorporated
in Delaware, but, because our sample focuses on firms that issue public debt
and because firms with a high debt use are more likely to incorporate in Delaware,
58.8 percent of the debt issues are for firms incorporated in Delaware.
Table 3 presents the correlations between our explanatory variables and two
11
In contrast, the mean number of covenants in private loan agreements decreased to five in 2005,
from six in the preceding 3 years (Ng 2006).

190
Figure 1. Total number of covenants, by year
dependent variables, an indicator of whether any covenants are included and

the total number of covenants. Consistent with our prediction of substitution
between state laws and covenants, we find significant negative coefficients between the total asset constraint and the total number of covenants, as well as
between the antitakeover index and the total number of covenants. We consider
below the degree to which these negative correlations are robust when other
factors are controlled.
In addition, we consider the variation of these covenants across time. Figure
2 presents the frequency of payout and financing covenants for different years
in our sample. Because the use of these covenants may be a response to the
threat of default, we also include the default rate in this figure. Figure 2 demonstrates the enormous increase in the use of the negative-pledge and crossacceleration covenants after 1990. Other payout and financing covenants also
became more frequently used after 1992.12 Similarly, Figure 3 presents the frequency of the use of event-risk covenants. The use of the consolidation/merger
covenant increased significantly after 1989, whereas the RDTP covenant was used
primarily in only 1989 and 1990. Figure 4 presents the frequency of use of the
asset substitution covenants. A covenant requiring the redemption of bonds at
the sale of certain assets was not used until 1993 but appears in 26.5 percent of
12
The increase in the use of more general payout-restriction covenants substitutes for a sharp
decrease in the use of dividend-restriction covenants after 1990. Dividend-restriction covenants
appeared in approximately 17 percent of 1987 issues, but their use drops to less than 1 percent after
2000. This change in type of covenant corresponds to the increase in repurchases relative to dividends
in the late 1980s (see Grullon and Michaely 2002).

Debt Covenants
191
Figure 2. Frequency of payment and financing covenants
issues in 2004. A subsidiary sales leaseback covenant was not used by any firms
in our sample in 1987 but appears in 53.6 percent of issues in 1999. Although
state laws, firm characteristics, and other security characteristics are able to
explain much of the variation in covenant use, they do not explain fully the
tremendous variation over time in some of these covenants. Instead, changes in
covenant use over time are consistent with legal innovations or fashions creating
new trends in covenant use. Consistent with payout-restriction covenants replacing dividend-restriction covenants after an increase in repurchases and with
the increase in restrictions on mergers after the merger wave in the late 1980s,
covenant use responds to what creditors perceive as the most likely threats of
expropriation.
4.2. Impact of State Law on Covenant Use: Univariate Tests
Table 4 presents the results of two-sided t-tests for whether the frequencies
of the more common financing, merger, or asset-substitution covenants are
different in states with a total asset constraint equal to zero or one. Consistent
with substitution between state laws and debt covenants, most financing covenants appear less frequently in states with stricter payout-restriction laws. For
instance, in states with a total asset constraint equal to one, restricted-payments
clauses appear 9 percentage points less frequently than in those states with a
total asset constraint equal to zero. This reduction (by approximately one-third)
in the use of this covenant is both statistically and economically meaningful.
Other common covenants also are less frequently used in states with stricter
total asset constraints, and these differences are often statistically significant.

192

Leverage
Firm size
Log(issue amount)
Market
Antitakeover index
Total covenants
.331
(.00)
.011
(.42)
.025
(.07)
.023
(.10)
.100
(.00)
.075
(.00)
.036
(.01)
.040
(.00)
.098
(.00)
.032
(.02)
.231
(.00)
.036
(.01)
.543
(.00)
.013
(.33)
.116
(.00)
.826
(.00)
.060
(.00)
.143
(.00)
.088
(.00)
.082
(.00)
.026
(.03)
.048
(.00)
.090
(.00)
.061
(.00)
.100
(.00)
.024
(.08)
.015
(.27)
.392
(.00)
.237
(.00)
.186
(.00)
.283
(.00)
.052
(.00)
.105
(.00)
Total
Any
Total
Asset
Antitakeover
Log(Issue
Covenant Covenants Constraint
Index
Market Amount)
.258
(.00)
.199
(.00)
Firm
Size
Ratio
.496
(.00)
Market R&D to
Log
Leverage to Book Assets (Maturity) Putable Callable
Table 3
Correlation Coefficients and Significance Levels
193

.003
(.82)
.031
(.02)
.043
(.00)
.076
(.00)
.029
(.03)
.026
(.05)
.132
(.00)
.079
(.00)
.397
(.00)
.034
(.01)
.016
(.23)
.025
(.07)
.020
(.15)
.004
(.76)
.132
(.00)
.067
(.00)
.017
(.21)
.013
(.34)
.027
(.05)
.065
(.00)
.070
(.00)
.047
(.00)
.008
(.58)
.151
(.00)
.020
(.15)
.097
(.00)
.072
(.00)
.024
(.08)
.007
(.59)
.299
(.00)
.029
(.03)
.032
(.02)
.001
(.96)
.374
(.00)
.106
(.00)
.292
(.00)
.161
(.00)
.043
(.00)
.100
(.00)
.093
(.00)
.309
(.00)
.009
(.51)
.017
(.21)
.107
(.00)
.060
(.00)
.094
(.00)
.035
(.01)
.043
(.00)
.063
(.00)
.196
(.00)
.070
(.00)
.052
(.00)
.022
(.10)
.011
(.44)
.069
(.00)
Note. Data are based on 5,514 debt issues by 1,444 firms. Total asset constraint is the minimum asset-to-debt ratio required for a distribution to shareholders, given the
firms state of incorporation. The antitakeover index gives the number of antitakeover statutes, given the firms state of incorporation (as in Bebchuk and Cohen 2003),
plus 1.0 if antigreenmail laws are in effect (that is, if the firm is incorporated in Pennsylvania or Ohio, which have a recapture or disgorgement statute in effect after 1990).
Market is the size of the issue relative to the firms total debt. Log(issue amount) measures the size of the issue in millions of dollars. Firm size equals the log of the firms
total assets. Leverage is the firms debt divided by total market value, at the year of issuance. Market-to-book ratio is the sum of the market value of the firms equity plus
the sum of the book value of the firms debt and preferred stock, all divided by total assets. The R&D-to-assets ratio equals the firms research and development expenses
divided by total assets or zero if R&D is missing. Maturity is the number of years to maturity of the issue. Putable equals one if the issue includes a put, and callable equals
one if the issue includes a call. Secured equals one if the debt is senior secured and zero otherwise. Values in parentheses are p-values.
Secured
Callable
Putable
Log(maturity)
R&D-to-assets ratio
194
Figure 3. Frequency of event-risk covenants
Similarly, we examine univariate tests for the frequency of covenant use for
bonds issued by firms incorporated in states with a 1.25 asset-to-debt payout
restriction; however, because there are only 36 bond issues from firms incorporated in such states, these results are not presented. However, in every case,
firms incorporated in states with a 1.25 payout restriction use covenants less
frequently, and, even with only 36 observations, the differences for negativepledge covenants, sales leaseback covenants, and subsidiary sales leaseback covenants are statistically significant.13
4.3. Impact of State Law on Covenant Use: Regressions
Table 5 presents the results of a probit regression on whether the issue includes
any covenants and a Poisson regression on the total number of covenants in the
debt issue. The independent variables include the total asset constraint and the
antitakeover index (for the state in which the issuing firm is incorporated),
controls for firm characteristics, controls for characteristics of the debt issue,
and macroeconomic controls. For both the probit and Poisson regressions, the
variable for the total asset constraint is significant and negative. However, unlike
in the raw correlations, the antitakeover index is positive and significant in both
cases. These results suggest substitution in the case of payout constraints but
complementarity in the case of antitakeover statutes. Since the determining factors for different types of covenants may not be similar, a Poisson regression
13
For instance, subsidiary sales leaseback covenants appear in only 11 percent of bond issues by
firms incorporated in a state with a 1.25 asset-to-debt payout restriction, compared with 44.1 percent
of bond issues by firms incorporated in a state with a 0 asset-to-debt payout restriction.

Debt Covenants
195
Figure 4. Frequency of asset sales covenants
may be misspecified. We therefore consider the most commonly used payout,

financing, event-risk, and asset-substitution covenants separately.
Table 6 presents the results of probit regressions on the payout and financing
restrictions used more than 10 percent of the time. These covenants include the
restricted-payments covenant (which restricts repurchases as well as other potential payments to shareholders), subsidiary dividend-related payments covenant, the firms overall indebtedness, the subsidiarys indebtedness, the negativepledge covenant, and a cross-acceleration covenant. Consistent with a substitution effect, incorporation in a state with a larger total asset constraint is
negatively associated with the usage of either the restricted-payments or the
subsidiary dividend-related payments covenant. In terms of economic impact,
a marginal increase in the total asset constraint (roughly corresponding to a
change from zero to one in the total asset constraint) corresponds to a 6.6
percent decrease in the fitted frequency of the restricted-payments covenant and
a 4.2 percent decrease in the use of the subsidiary dividend-related payments
covenant, when all other variables are evaluated at their mean values. Because
these covenants appear in 21.0 percent and 19.2 percent of issues, respectively,
the fitted decreases correspond to relatively large changes.
For covenants that restrict the firms or the subsidiarys total debt, there is
less of a direct substitution with the total asset constraint. The coefficients for
the total asset constraint are negative for both the indebtedness and subsidiary
indebtedness regressions in Table 6; however, only the coefficient for subsidiary
indebtedness is significantly different from zero. Another financing-related covenant is the negative-pledge covenant, which requires that secured debt can be

196

Table 4
Covenant Use by State Law Restrictions
State Law Restriction
Covenant
Payout:
Restricted payments
Subsidiary restricted payments
Financing:
Indebtedness
Negative pledge
Cross acceleration
Event risk:
Poison put
RDTP
Asset substitution:
Asset sales clause
Sales leaseback restriction
Subsidiary sales leaseback
restriction
Difference in
Means: No Total
Asset Constraint
versus Total
Asset Constraint
Equals One (tStatistic)
No Total Asset
Constraint (SD)
Total Asset
Constraint Equals
One (SD)
.247 (.431)
.223 (.417)
.157 (.364)
.147 (.354)
.090** (8.311)
.077** (7.310)
.262
.281
.749
.553
.242
.241
.622
.486
.020
.040**
.127**
.067**
(.440)
(.449)
(.433)
(.497)
(.428)
(.428)
(.485)
(.500)
(1.686)
(3.320)
(9.915)
(4.859)
.264 (.441)
.890 (.313)
.018 (.133)
.185 (.388)
.859 (.348)
.026 (.159)
.079** (7.018)
.031** (3.330)
.008 (1.922)
.888 (.315)
.177 (.382)
.468 (.499)
.854 (.353)
.099 (.298)
.422 (.494)
.034** (3.618)
.078** (8.511)
.047** (3.423)
.441 (.497)
.385 (.487)
.056** (4.117)
Note. Data are results of two-sided t-tests for correlation between covenant use and state law and are
based on 3,277 debt issues when payout restriction equals zero and 2,201 debt issues when payout restriction
equals one. Total asset constraint equals the minimum ratio of assets to liabilities for a payout. Unequal
variances are assumed for all tests. RDTP p rating decline triggers put.
Significant at the 10% level.

** Significant at the 1% level.
issued only if the current issue also is secured. If the firms total assets are
restricted, this covenant may be less necessary. We find a significant negative
coefficient for the total asset constraint in regressions for the use of the negativepledge covenant. The marginal impact implies that an average firm incorporated
in a state with a total asset constraint equal to one is approximately 20 percent
less likely to use this covenant than is a similar firm in a state with a total asset
constraint equal to zero. An additional covenant that considers the rights of
bondholders relative to other creditors is the cross-acceleration covenant. This
covenant allows bondholders to accelerate payments on their debt if any other
debt has received accelerated payments owing to default. As with most other
financing covenants, a states total asset constraint is negatively and significantly
associated with the use of cross-acceleration covenants.
We find that the antitakeover index is positively and significantly associated
with most of these covenants. For instance, the coefficient for the antitakeover
index is positive and significant at the 1 percent level for the restricted-payments
covenant. At the margin, a 1-point increase in the antitakeover index corresponds

Debt Covenants
197
Table 5
Probit Regression on If Covenants Are Used and Poisson
Regression on Number of Covenants Used
Covenants Used?
Constant
Antitakeover index
Market
Log(issue amount)
Firm size
Leverage
R&D-to-assets ratio
Log(maturity)
High yield
Putable
Callable
Secured
Default ratet1 (%)
Log(mergerst1)
2.216**
.377**
.127**
.119*
.111**
.117**
.162
.014
.454
.112*
.120
.371*
.236**
.012
.051
.021
(6.407)
(2.986)
(3.136)
(2.356)
(3.813)
(3.513)
(.702)
(.187)
(.244)
(2.249)
(1.026)
(2.184)
(2.716)
(.056)
(1.325)
(.758)
Total Number of Covenants

2.785**
.220**
.051**
.030*
.112**
.150**
.191**
.012
.695*
.053**
.345**
.190**
.202**
.142**
.003
.004
(26.839)
(6.655)
(5.423)
(2.424)
(6.364)
(12.800)
(3.052)
(1.075)
(2.269)
(4.433)
(10.909)
(3.173)
(10.001)
(2.783)
(.303)
(.562)
Note. Regressions are based on data for 5,514 debt issues by 1,444 firms. White heteroskedastically consistent t-statistics, adjusted for clustering by firm, are in parentheses. Total asset constraint is the minimum
asset-to-debt ratio required for a distribution to shareholders, given the firms state of incorporation. The
antitakeover index gives the number of antitakeover statutes, given the firms state of incorporation (as in
Bebchuk and Cohen 2003), plus 1.0 if antigreenmail laws are in effect (that is, if the firm is incorporated
in Pennsylvania or Ohio, which have a recapture or disgorgement statute in effect after 1990). Market is
the size of the issue relative to the firms total debt. Log(issue amount) measures the size of the issue in
millions of dollars. Firm size equals the log of the firms total assets. Leverage is the firms debt divided
by total market value, at the year of issuance. Market-to-book ratio is the sum of the market value of the
firms equity plus the sum of the book value of the firms debt and preferred stock, all divided by total
assets. The R&D-to-assets ratio equals the firms research and development expenses divided by total assets
or zero if R&D is missing. Maturity is the number of years to maturity of the issue. High yield equals one
if the issue is rated less than BAA by Moodys. Putable equals one if the issue includes a put, and callable
equals one if the issue includes a call. Secured equals one if the debt is senior secured and zero otherwise.
The default rate is for all bonds rated by Standard & Poors in the prior year, and log(mergerst1) is the
log of the market value of mergers in the corresponding one-digit standard industrial classification code
in the prior year.
* Significant at the 5% level.
to an increase of 1.3 percent in the frequency with which this covenant is used,
when all other variables are evaluated at their mean values.
Table 7 considers the correlation between state laws and antitakeover covenants. These include the poison put provision, the consolidation/merger restriction, and the put in the event of a rating decline. Although the RDTP covenant
is used infrequently (only 2.1 percent of corporate bond issues include this
covenant) and is not usually considered a pure takeover restriction, Kahan and
Klausner (1993) discuss how this covenant more effectively protects bondholders
in the event of a takeover. They suggest that other antitakeover covenants, such
as the poison put, are more effective at entrenching management than they are
at protecting bondholders. Instead of a substitution effect, we find that state
antitakeover laws are positively correlated with these antitakeover covenants.
Our estimated coefficients are significant at the 1 percent level in the case of


1.838**
.611**
.120**
.030
.433**
.529**
2.015**
.065
.766
.338**
1.304**
1.370*
.900**
.056
.025
.066*
(3.829)
(4.153)
(2.837)
(.580)
(3.560)
(7.363)
(7.374)
(1.230)
(.473)
(5.502)
(11.999)
(2.486)
(7.959)
(.253)
(.619)
(2.125)
2.376**
.501**
.104*
.032
.413**
.529**
1.523**
.017
1.508
.392**
1.252**
1.799**
.922**
.048
.016
.086**
(4.999)
(2.877)
(1.997)
(.698)
(3.385)
(7.352)
(5.642)
(.311)
(1.050)
(6.898)
(12.382)
(3.910)
(8.115)
(.282)
(.438)
(2.818)
Subsidiary
Dividend-Related
Payments
2.434**
.166
.099**
.066
.259**
.535**
1.974**
.073
3.599*
.372**
.868**
.630*
.781**
.161
.038
.013
(5.380)
(1.145)
(2.608)
(1.198)
(3.588)
(9.897)
(7.318)
(1.757)
(2.067)
(6.923)
(8.461)
(2.014)
(7.578)
(.737)
(1.086)
(.400)
Indebtedness
2.155**
.328*
.100*
.069
.297**
.519**
1.351**
.050
3.067
.291**
.759**
.502
.695**
.124
.018
.001
(4.784)
(2.222)
(2.551)
(1.290)
(3.952)
(10.144)
(4.980)
(1.202)
(1.609)
(5.439)
(7.423)
(1.682)
(7.249)
(.617)
(.559)
(.021)
Subsidiary
Indebtedness
.753*
(1.961)
.587** (4.317)
.087*
(2.415)
.082* (2.546)
.133*
(2.316)
.057 (1.401)
.668* (2.386)
.064
(.882)
8.286** (2.838)
.055
(1.252)
.021
(.225)
.089
(.698)
.070
(.991)
1.408**(8 .433)
.034
(1.089)
.031 (1.216)
Negative
Pledge
2.759** (6.777)
.294* (2.043)
.041
(1.013)
.066 (1.323)
.118** (3.361)
.313** (8.627)
.488
(1.823)
.009
(.145)
5.983** (3.463)
.164** (3.997)
.341** (3.462)
.206 (1.474)
.247** (3.438)
.782**(4 .900)
.110** (3.905)
.010
(.357)
Cross
Acceleration
Note. Results are from probit regressions based on 5,514 debt issues by 1,444 firms. White heteroskedastically consistent t-statistics, adjusted for clustering by firm, are
in parentheses. Total asset constraint is the minimum asset-to-debt ratio required for a distribution to shareholders, given the firms state of incorporation. The antitakeover
index gives the number of antitakeover statutes, given the firms state of incorporation (as in Bebchuk and Cohen 2003), plus 1.0 if antigreenmail laws are in effect
(that is, if the firm is incorporated in Pennsylvania or Ohio, which have a recapture or disgorgement statute in effect after 1990). Market is the size of the issue relative
to the firms total debt. Log(issue amount) measures the size of the issue in millions of dollars. Firm size equals the log of the firms total assets. Leverage is the firms
debt divided by total market value, at the year of issuance. Market-to-book ratio is the sum of the market value of the firms equity plus the sum of the book value of
the firms debt and preferred stock, all divided by total assets. The R&D-to-assets ratio equals the firms research and development expenses divided by total assets or
zero if R&D is missing. Maturity is the number of years to maturity of the issue. High yield equals one if the issue is rated less than BAA by Moodys. Putable equals
one if the issue includes a put, and callable equals one if the issue includes a call. Secured equals one if the debt is senior secured and zero otherwise. The default rate
is for all bonds rated by Standard & Poors in the prior year, and log(mergerst1) is the log of the market value of mergers in the corresponding one-digit standard
industrial classification code in the prior year.

Constant
Antitakeover index
Market
Log(issue amount)
Firm size
Leverage
R&D-to-assets ratio
Log(maturity)
High yield
Putable
Callable
Secured
Default ratet1 (%)
Log(mergerst1)
Restricted
Payments
Table 6
Use of Payout or Financing Covenants
Debt Covenants
199
Table 7
Use of Event-Risk Covenants
Poison Put
Constant
Antitakeover index
Market
Log(issue amount)
Firm size
Leverage
R&D-to-assets ratio
Log(maturity)
High yield
Putable
Callable
Secured
Default ratet1 (%)
Log(mergerst1)
2.268**
.420**
.084*
.062
.398**
.513**
1.796**
.027
.451
.186**
1.128**
.848*
.560**
.063
.052
.079**
(5.378)
(2.732)
(2.262)
(1.272)
(4.150)
(8.625)
(7.464)
(.555)
(.280)
(2.905)
(11.106)
(2.342)
(5.474)
(.411)
(1.549)
(2.965)
Consolidation/Merger
1.104*
.257*
.105**
.056
.129**
.176**
.386
.048
1.943
.124**
.161
.037
.213**
1.583**
.093*
.097**
(2.106)
(2.024)
(3.114)
(1.229)
(3.633)
(4.369)
(1.562)
(.943)
(.855)
(2.833)
(1.175)
(.262)
(2.783)
(8.391)
(2.386)
(2.928)
RDTP
.310
.227
.133*
.081
.130
.238**
.656
.113
6.536
.105
.168
.159
.463**
.864*
.056
.073*
(.646)
(.912)
(2.068)
(1.450)
(1.463)
(3.869)
(1.909)
(1.883)
(1.512)
(1.455)
(1.100)
(.500)
(3.137)
(2.245)
(1.170)
(2.355)
Note. Results are from probit regressions are based on 5,514 debt issues by 1,444 firms. White heteroskedastically consistent t-statistics, adjusted for clustering by firm, are in parentheses. Total asset constraint
is the minimum asset-to-debt ratio required for a distribution to shareholders, given the firms state of
incorporation. The antitakeover index gives the number of antitakeover statutes, given the firms state of
incorporation (as in Bebchuk and Cohen 2003), plus 1.0 if antigreenmail laws are in effect (that is, if the
firm is incorporated in Pennsylvania or Ohio, which have a recapture or disgorgement statute in effect
after 1990). Market is the size of the issue relative to the firms total debt. Log(issue amount) measures
the size of the issue in millions of dollars. Firm size equals the log of the firms total assets. Leverage is
the firms debt divided by total market value, at the year of issuance. Market-to-book ratio is the sum of
the market value of the firms equity plus the sum of the book value of the firms debt and preferred stock,
all divided by total assets. The R&D-to-assets ratio equals the firms research and development expenses
divided by total assets or zero if R&D is missing. Maturity is the number of years to maturity of the issue.
High yield equals one if the issue is rated less than BAA by Moodys. Putable equals one if the issue includes
a put, and callable equals one if the issue includes a call. Secured equals one if the debt is senior secured
and zero otherwise. The default rate is for all bonds rated by Standard & Poors in the prior year, and
log(mergerst1) is the log of the market value of mergers in the corresponding one-digit standard industrial
classification code in the prior year. RDTP p rating decline triggers put.
Significant at the 10% level

* Significant at the 5% level
the general consolidation/merger covenant and at the 5 percent level for poison
puts and the RDTP covenant. In this case, instead of state laws substituting for
debt covenants, we find that firms with state antitakeover protection are more
likely to add further debt protection. This result is consistent with those firms
most at risk of a takeover adding whatever additional protections that they can;
that is, bondholders of firms more at risk of takeover may place a higher value
on protection from antitakeover covenants, and these firms also may be the ones
most likely to incorporate in a state with more protection. Alternatively, this
result also may reflect how management that is more entrenched (as measured
by antitakeover statutes) adds additional takeover defenses at the expense of
shareholders to further entrench their position. Since Mansi, Maxwell, and Wald
(2006) find little evidence that bondholders place value on these state antitakeover
laws, the latter explanation seems more likely.

200
In an alternative specification, we add year dummy variables to all the regressions. Because the antitakeover index is correlated with time effects, the
addition of time dummy variables reduces the significance of the antitakeover
index in the regressions for event-risk covenants. These results suggest that the
antitakeover index is one possible cause in the increased use of antitakeover
covenants, but other time-varying effects may be responsible. Time dummy
variables do not significantly change our other results with respect to either the
total asset constraint or the overall increased use of covenants by firms subject
to a higher antitakeover index.
In terms of cross effects, we find some evidence that issues subject to a more
restrictive total asset constraint are less likely to include event-risk protection,
whereas issues subject to stronger state antitakeover laws are somewhat more
likely to include payout or financing restrictions. These results are consistent
with the findings of Lehn and Poulsen (1991), who suggested that firms that
use a payout covenant are more likely to include event-risk covenants. Thus,
stricter total asset constraints have some spillover effects with regard to other,
less directly related protections. In alternative regressions, we also included the
number of other covenants in the probit regressions. In all cases, the use of more
other covenants implied a higher probability of the addition of a covenant, which
suggests a declining marginal cost for additional covenants.
We also consider the impact of these laws on asset sales restrictions in Table
8. Restrictions on assets are related to additional financing restrictions because
they often require the redemption of debt in the event of certain sales. These
restrictions are split into several types based on a direct restriction on the sale
of certain assets, a requirement that proceeds be used to redeem debt, or a
restriction on sales leaseback transactions, in which an asset is sold and then
leased back by the company. In each case, the use of these covenants is negatively
associated with the total asset constraint, which suggests that state payout restrictions that limit the disposition of assets can substitute for some of these
more specific limitations. In three of four cases, we also find that firms with a
higher antitakeover index use these covenants significantly more frequently. Consistent with the results of Chava, Kumar, and Warga (2005), this finding suggests
that firms with managers who are more entrenched may be subject to additional
agency costs and that covenants may be needed to reduce these agency problems.
To further examine whether other agency controls could better explain covenant use, we include the index of Gompers, Ishii, and Metrick (2003) and data
on institutional blockholder ownership used by Cremers and Nair (2005) in
these regressions.14 However, since these variables are not significant in any
regressions, we do not include them in our final specification.
Overall, we find strong evidence for rejecting our first null hypothesis: state
payout restrictions are negatively correlated with the use of a number of similar
14
We thank Cremers and Nair (2005) for providing access to their data on institutional blockholder
ownership.


2.331**
.488**
.044
.071*
.487**
.466**
.841**
.009
2.557
.288**
1.401**
.743
1.012**
.028
.129**
.224**
(4.049)
(3.293)
(1.047)
(1.980)
(7.568)
(8.578)
(3.498)
(.185)
(1.532)
(4.857)
(9.492)
(1.543)
(7.104)
(.190)
(3.321)
(5.420)
1.002
.249*
.100**
.053
.129**
.167**
.417
.024
1.294
.129**
.179
.012
.223**
1.585**
.094*
.098**
(1.922)
(1.981)
(2.982)
(1.157)
(3.608)
(4.174)
(1.699)
(.451)
(.592)
(2.980)
(1.323)
(.086)
(2.936)
(8.496)
(2.398)
(2.945)
Asset Sales
Restriction
.662
.503**
.110*
.175**
.258**
.206**
1.308**
.101
13.746**
.126**
.194*
.085
.067
.471*
.050
.048*
(1.549)
(2.866)
(2.246)
(5.814)
(3.686)
(5.512)
(5.220)
(1.541)
(4.195)
(2.732)
(1.977)
(.593)
(.889)
(2.555)
(1.856)
(2.037)
Sales Leaseback
Restrictions
.055
.598**
.134**
.176**
.373**
.233**
1.307**
.083
11.616**
.121**
.194*
.027
.007
.411*
.029
.033
(.129)
(3.711)
(3.052)
(5.764)
(5.609)
(6.149)
(5.134)
1.417)
(4.327)
(2.637)
(1.965)
(.180)
(.101)
(2.303)
(1.104)
(1.400)
Subsidiary Sales
Leaseback Restrictions
Note. Results are from probit regressions based on 5,514 debt issues by 1,444 firms. White heteroskedastically consistent t-statistics, adjusted for clustering by firm,
are in parentheses. Total asset constraint is the minimum asset-to-debt ratio required for a distribution to shareholders, given the firms state of incorporation. The
antitakeover index gives the number of antitakeover statutes, given the firms state of incorporation (as in Bebchuk and Cohen 2003), plus 1.0 if antigreenmail laws
are in effect (that is, if the firm is incorporated in Pennsylvania or Ohio, which have a recapture or disgorgement statute in effect after 1990). Market is the size of the
issue relative to the firms total debt. Log(issue amount) measures the size of the issue in millions of dollars. Firm size equals the log of the firms total assets. Leverage
is the firms debt divided by total market value, at the year of issuance. Market-to-book ratio is the sum of the market value of the firms equity plus the sum of the
book value of the firms debt and preferred stock, all divided by total assets. The R&D-to-assets ratio equals the firms research and development expenses divided by
total assets or zero if R&D is missing. Maturity is the number of years to maturity of the issue. High yield equals one if the issue is rated less than BAA by Moodys.
Putable equals one if the issue includes a put, and callable equals one if the issue includes a call. Secured equals one if the debt is senior secured and zero otherwise.
The default rate is for all bonds rated by Standard & Poors in the prior year, and log(mergerst1) is the log of the market value of mergers in the corresponding onedigit standard industrial classification code in the prior year.

Constant
Antitakeover index
Market
Log(issue amount)
Firm size
Leverage
R&D-to-assets ratio
Log(maturity)
High yield
Putable
Callable
Secured
Default ratet1 (%)
Log(mergerst1)
Asset Sales Require

Redemption
Table 8
Use of Asset-Restriction Covenants
202
and less similar covenants. We also find some evidence for rejecting our second
null hypothesis: antitakeover laws appear to be positively correlated with some
covenants, although this positive correlation is weakened when year dummy
variables are included in the regressions for event-risk covenants.
4.4. Control Variables and Covenants
A number of our control variables have an impact on the use of covenants,
and we briefly review the theory and prior empirical findings related to these
variables. Malitz (1986) hypothesizes and finds that smaller firms are more likely
to use covenants, higher-leverage firms are more likely to use covenants, and
issues that are a larger proportion of the firms total debt are more likely to
have covenants attached. Consistent with her findings, we find that larger firms
are significantly less likely to include any of the covenants that we examine. Our
findings on leverage are somewhat mixed because we use two control variables
for leverage, a debt-to-market ratio and a dummy variable equal to one if the
debt is rated high yield (less than BAA by Moodys). We find significant positive
coefficients for leverage in nine regressions and significant negative coefficients
in three regressions. We also find significant coefficients for the high-yield variable
in most cases, which suggests a nonlinear relation between leverage and covenant
use. In contrast to Malitz (1986), we find negative coefficients in four regressions
for the market variable, equal to the size of the issue relative to the firms total
debt. We also control for the log of issue amount, hypothesizing that larger issue
size may have an impact on covenant choice. The fixed costs of negotiating
covenants may be less significant if the total size of the deal is larger; thus, we
expect to find a positive coefficient for this variable. We find that the coefficient
for deal size is positive and significant in all our regressions, with the exception
of that for the RDTP covenant (used in only a small fraction [2.1 percent] of
the issues that we examine).
Nash, Netter, and Poulsen (2003) hypothesize and find that firms with greater
growth options may prefer the financial flexibility implied by fewer covenants.
As in their regressions, we include market-to-book and R&D-to-assets ratios as
additional control variables. We find that the R&D-to-assets ratio variable has
a negative coefficient for all the financing covenants, with the exception of the
negative-pledge covenant. (Nash, Netter, and Poulsen [2003] find similar results.)
Use of R&D is not significantly related to the use of event-risk protection, but
firms with a higher R&D-to-assets ratio are more likely to include sales leaseback
covenants. The market-to-book ratio variable is not significantly correlated with
use of most of the covenants that we consider, although it is positively correlated
with indebtedness (at the 10 percent level) and with the RDTP covenant.
Agency problems are more likely to occur when the debts maturity is longer,
and we therefore anticipate that covenants will be more frequent in these cases.
Similarly, we anticipate that a bond issue with a put feature may reduce agency
conflicts and make protective covenants less likely. However, we find significant

Debt Covenants
203
negative coefficients for maturity in nine of our probit regressions and significant
positive coefficients in the regressions for negative-pledge covenants and sales
leaseback covenants. Consistent with our expectations, the variable for putable
bond flag has negative coefficients in all our regressions, and five of these coefficients are significant.
Bodie and Taggart (1978) suggest that callable bonds would need covenants
less frequently, since the call can act to reduce agency conflict. However, we find
that callable bonds are more likely to include most of the covenants that we
consider. We find significant positive coefficients in nine of our regressions and
a significant negative coefficient for the RDTP covenant.
Debt features, such as maturity and whether the debt includes a call or put,
may be considered part of the same bargaining process that produces covenants;
thus, these features may be endogenous to the covenant decision. We therefore
ran all our regressions after excluding these three variables and found little impact
on the state law coefficients in these alternative specifications.
Last, we consider macroeconomic effects, such as the default rate in the prior
year and the dollar value of merger activity in the firms industry in the prior
year. Lehn and Poulsen (1991) show that event-risk protection increased after
the increase in merger activity in the 1980s. We therefore expect a positive
coefficient for both default rate and merger variables. Instead, the coefficients
for default rate are rather mixed, with significant positive coefficients for the
consolidation/merger covenant and three of the asset sales restrictions but a
significant negative coefficient for the cross-acceleration covenant. Similarly, the
lagged variable for merger activity provides mixed results, with significant negative coefficients for the poison put and RDTP covenants but a significant positive
coefficient for the consolidation/merger covenant.
5. Conclusion
We analyzed the use of debt covenants in relation to state laws to determine
whether state laws are substitutes for or complements to (or neither) specific
debt restrictions. We find that state laws that restrict payouts appear to substitute
for a variety of debt covenants, including restrictions on payments, negativepledge covenants, and asset-substitution covenants. Stronger payout restrictions
also diminish the likelihood of the use of antitakeover covenants such as poison
puts, possibly because these restrictions reduce the benefits gained from the
addition of any covenants to the debt contract.
These findings are consistent with a costly contracting explanation of covenant
choice, and they demonstrate how laws can substitute for individual contracts.
Although state payout laws also may reduce the financial flexibility of certain
firms, a variety of legal environments exist in the United States, and firms can
reincorporate in states with fewer restrictions if these prohibitions become overly
binding.
We also find some evidence that the number of antitakeover statutes in the

204
firms state of incorporation is positively correlated with the use of antitakeover

covenant defenses. This finding is consistent with managers of firms who are
more entrenched being able to add covenants that reduce the probability of
takeover. In addition, as discussed by Gompers, Ishii, and Metrick (2003), antitakeover laws may reduce the effectiveness of a firms governance. Firms with
greater governance problems may be more subject to agency issues, and their
debt may include more covenants in order to reduce these agency problems.
Although state laws, firm characteristics, and issue characteristics help to explain the use of debt covenants, their use also varies between years in a way that
cannot be fully explained by the macroeconomic variables, overall default rates,
and takeover activity that we considered. While the interaction between state
laws and covenants presented here extends our understanding of covenant choice,
some portion of covenant usage may be explained best by legal innovation and
trends among corporate lawyers.
Appendix
Table A1
Definitions of Frequently Used Covenants
Covenant
Category
Dividend-related
payments
Payout
Restricted payments
Payout
Subsidiary dividendrelated payments
Payout
Indebtedness
Financing
Negative pledge
Financing
Financing
Cross acceleration
Financing
Asset
Description
Indicates that payments made to shareholders or other
entities may be limited to a certain percentage of net
income or some other ratio
Restricts the issuers freedom to make payments to
shareholders and others; may restrict the purchasing or
redemption of any capital stock of the company or of
any warrants, rights, or options to purchase or acquire
shares of any class or the making of any principal
payment prior to any schedules maturity
Limits subsidiaries payment of dividends to a certain
percentage of net income or some other ratio; for
captive finance subsidiaries, this provision limits the
amount of dividends that can be paid to the parent
firm; this provision protects the bondholder from a
parent firm draining assets from its subsidiaries
Restricts the user from incurring additional debt by
limiting the absolute dollar amount of debt outstanding
or the percentage of total capital
Restricts the total indebtedness of subsidiaries
Prevents the issuance of secured debt unless the issuer
secures the current issue on a pari passu basis
Protects bondholders by allowing them to accelerate their
debt if any other debt of the organization has been
accelerated owing to a default event
Restricts the ability of an issuer to sell assets or
restrictions on the issuers use of the proceeds from the
sale of assets; such restrictions may require the issuer
to apply some or all of the sales proceeds to the
repurchase of debt through a tender offer or call

Debt Covenants
205
Table A1 (Continued )
Covenant
Category
Sales leaseback
restriction
Asset
Subsidiary sales
leaseback restriction
Asset
Asset sales require

redemption
Asset
Takeover
Poison put
Takeover
RDTP
Takeover
Description
Restricts the issuer to the type or amount of property
used in a sales leaseback transaction and may restrict
its use of the proceeds of the sale
Restricts subsidiaries from selling and then leasing back
assets that provide security for the bondholder; this
provision usually requires that assets or cash equal to
the property sold and leased back be applied to the
retirement of the debt in question or used to acquire
another property to increase the debtholders security
Requires the issuer to use net proceeds from the sale of
certain assets to redeem the bonds at par or at a
premium; this covenant does not limit the issuers right
to sell assets
Indicates that a consolidation or merger of the issuer with
another entity is restricted and often requires that the
surviving corporation assumes all debts; thus, this
covenant is not binding for most acquisitions
Upon a change of control in the issuer, bondholders have
the option of selling the issue back to the issuer; other
conditions may limit the bondholders ability to
exercise the put option; poison puts often are used
when a company fears an unwanted takeover, thus
ensuring that a successful hostile-takeover bid will
trigger an event that substantially reduces the value of
the company
Rating decline triggers put; a decline in the credit rating
of the issuer (or issue) triggers a bondholder put
provision
References
Asquith, Paul, and Thierry A. Wizman. 1990. Event Risk, Covenants, and Bondholder
Returns in Leveraged Buyouts. Journal of Financial Economics 27:195213.
Bebchuk, Lucian A., and Alma Cohen. 2003. Firms Decisions Where to Incorporate.
Journal of Law and Economics 46:383425.
Begley, Joy, and Gerald A. Feltham. 1999. An Empirical Examination of the Relation
between Debt Contracts and Management Incentives. Journal of Accounting and Economics 27:22959.
Billet, Matthew, Dolly King, and Dave Mauer. 2007. Growth Opportunities and the Choice
of Leverage, Debt Maturity, and Covenants. Journal of Finance 62:697730.
Bodie, Zvi, and Robert Taggart, Jr. 1978. Future Investment and the Value of the Call
Provision on a Bond. Journal of Finance 33:1187200.
Bradley, Michael, and Michael Roberts. 2004. The Structure and Pricing of Corporate
Debt Covenants. Working paper. Duke University, Fuqua School of Business, Durham,
N.C.
Chava, Sudheer, Praveen Kumar, and Arthur Warga. 2005. Agency Costs, Contracting
Efficiency, and Bond Covenants. Working paper. University of Houston, Bauer College
of Business, Houston.
Cooter, Robert. 1982. The Cost of Coase. Journal of Legal Studies 11:133.

206
Cremers, K. J. Martjin, and Vinay B. Nair. 2005. Governance Mechanisms and Equity
Prices. Journal of Finance 60:285994.
Cumming, Douglas, and Sofia Johan. 2006. Is It the Law or the Lawyers? Investment
Covenants around the World. European Financial Management 12:53574.
Doidge, Craig, G. Andrew Karolyi, and Rene M. Stultz. 2007. Why Do Countries Matter
So Much for Corporate Governance? Journal of Financial Economics 86:139.
Gartman, Grant. 2000. State Takeover Laws. Washington, D.C.: Investor Responsibility
Research Center.
Gompers, Paul A., Joy L. Ishii, and Andrew Metrick. 2003. Corporate Governance and
Equity Prices. Quarterly Journal of Economics 118:10755.
Gompers, Paul, and Josh Lerner. 1996. The Use of Covenants: An Empirical Analysis of
Venture Partnership Agreements. Journal of Law and Economics 39:46398.
Gore, Angela K., Kevin Sachs, and Charles Trzcinka. 2004. Financial Disclosure and Bond
Insurance. Journal of Law and Economics 47:275306.
Grullon, Gustavo, and Roni Michaely. 2002. Dividends, Share Repurchases, and the Substitution Hypothesis. Journal of Finance 57:164984.
Heron, Randall A., and Wilbur G. Lewellen. 1998. An Empirical Analysis of the Reincorporation Decision. Journal of Financial and Quantitative Analysis 33:54968.
Jensen, Michael C., and William H. Meckling. 1976. Theory of the Firm: Managerial
Behavior, Agency Costs and Ownership Structure. Journal of Financial Economics 3:
30560.
John, Kose, and Avner Kalay. 1982. Costly Contracting and Optimal Payout Constraints.
Journal of Finance 37:45770.
Kahan, Marcel, and Michael Klausner. 1993. Antitakeover Provisions in Bonds: Bondholder Protection or Management Entrenchment? UCLA Law Review 40:93182.
Kahan, Marcel, and David Yermack. 1998. Investment Opportunities and the Design of
Debt Securities. Journal of Economic Behavior and Organization 14:13653.
Kalay, Avner. 1982. Shareholder-Bondholder Conflict and Dividend Constraints. Journal
of Financial Economics 10:21133.
La Porta, Rafael, Florencio Lopez-de-Silanes, Andrei Shleifer, and Robert Vishny. 1997.
Legal Determinants of External Finance. Journal of Finance 52:113150.
. 1998. Law and Finance. Journal of Political Economy 106:111355.
. 2000. Investor Protection and Corporate Governance. Journal of Financial Economics 58:327.
Lehn, Kenneth, and Annette Poulsen. 1991. Contractual Resolution of Bondholder-Stockholder Conflicts in Leveraged Buyouts. Journal of Law and Economics 34:64573.
Malitz, Ileen. 1986. On Financial Contracting: The Determinants of Bond Covenants.
Financial Management 16:1825.
Mansi, Sattar A., William F. Maxwell, and John K. Wald. 2006. Do State Laws Matter for
Bondholders? Working paper. Virginia Polytechnic Institute and State University, Pamplin College of Business, Blacksburg.
Myers, Stewart C. 1977. The Determinants of Corporate Borrowing. Journal of Financial
Economics 5:14775.
Nash, Robert C., Jeffry M. Netter, and Annette B. Poulsen. 2003. Determinants of Contractual Relations between Shareholders and Bondholders: Investment Opportunities
and Restrictive Covenants. Journal of Corporate Finance 9:20132.
Ng, Serena. 2006. Easy Money? Banks Get Lenient on Loans. Wall Street Journal Online,
April 7. http://online.wsj.com/article/SB114437519584819660.htm.

Debt Covenants
207
Standard & Poors. 19862003. Quarterly Default Update and Rating Transitions. New
York: Standard & Poors.
Riesel, Natalia. 2004. On the Value of Restrictive Covenants: An Empirical Investigation
of Public Bond Issues. Working paper. Southern Methodist University, Department of
Finance, Dallas.
Smith, Clifford W., Jr., and Jerold B. Warner. 1979. On Financial Contracting: An Analysis
of Bond Covenants. Journal of Financial Economics 7:11761.
Wald, John K. 1999. Capital Structure with Dividend Restrictions. Journal of Corporate
Finance 5:193208.
Wald, John K., and Michael S. Long. 2007. The Effect of State Laws on Capital Structure.
Journal of Financial Economics 83:297319.
Wei, Chenyang. 2005. Covenant Protection, Credit Spread Dynamics, and Managerial
Incentives. Working paper. New York University, Stern School of Business, New York.


520005

Încărcat de

Informații document

Drepturi de autor

Formate disponibile

Partajați acest document

Partajați sau inserați document

Opțiuni de partajare

Vi se pare util acest document?

Este necorespunzător acest conținut?

Drepturi de autor:

Formate disponibile

520005

Încărcat de

Drepturi de autor:

Formate disponibile

The University of Chicago

The Booth School of Business of the University of Chicago

State Laws and Debt Covenants

This content downloaded from 119.226.90.54 on Tue, 1 Jul 2014 06:44:42 AM

State Laws and Debt Covenants

This content downloaded from 119.226.90.54 on Tue, 1 Jul 2014 06:44:42 AM

The Journal of LAW & ECONOMICS

tiated debt agreements. Instead of looking at contract differences across countries,

This content downloaded from 119.226.90.54 on Tue, 1 Jul 2014 06:44:42 AM

This content downloaded from 119.226.90.54 on Tue, 1 Jul 2014 06:44:42 AM

The Journal of LAW & ECONOMICS

This content downloaded from 119.226.90.54 on Tue, 1 Jul 2014 06:44:42 AM

covenants, which limit dividends, distributions, or dividends by subordinated

John and Kalay (1982) offer a model of optimal covenant choice.

This content downloaded from 119.226.90.54 on Tue, 1 Jul 2014 06:44:42 AM

The Journal of LAW & ECONOMICS

rarely in practice, we also consider them in our analysis of antitakeover

This content downloaded from 119.226.90.54 on Tue, 1 Jul 2014 06:44:42 AM

This content downloaded from 119.226.90.54 on Tue, 1 Jul 2014 06:44:42 AM

The Journal of LAW & ECONOMICS

This content downloaded from 119.226.90.54 on Tue, 1 Jul 2014 06:44:42 AM

This content downloaded from 119.226.90.54 on Tue, 1 Jul 2014 06:44:42 AM

This content downloaded from 119.226.90.54 on Tue, 1 Jul 2014 06:44:42 AM

analysis on those covenants closely related to payouts, financing, mergers, or

This content downloaded from 119.226.90.54 on Tue, 1 Jul 2014 06:44:42 AM

The Journal of LAW & ECONOMICS

Figure 1. Total number of covenants, by year

dependent variables, an indicator of whether any covenants are included and

This content downloaded from 119.226.90.54 on Tue, 1 Jul 2014 06:44:42 AM

Figure 2. Frequency of payment and financing covenants

This content downloaded from 119.226.90.54 on Tue, 1 Jul 2014 06:44:42 AM

This content downloaded from 119.226.90.54 on Tue, 1 Jul 2014 06:44:42 AM

Total asset constraint

This content downloaded from 119.226.90.54 on Tue, 1 Jul 2014 06:44:42 AM

The Journal of LAW & ECONOMICS

Figure 3. Frequency of event-risk covenants

This content downloaded from 119.226.90.54 on Tue, 1 Jul 2014 06:44:42 AM

Figure 4. Frequency of asset sales covenants

may be misspecified. We therefore consider the most commonly used payout,

This content downloaded from 119.226.90.54 on Tue, 1 Jul 2014 06:44:42 AM

The Journal of LAW & ECONOMICS

State Law Restriction

Significant at the 10% level.

This content downloaded from 119.226.90.54 on Tue, 1 Jul 2014 06:44:42 AM

Total Number of Covenants

This content downloaded from 119.226.90.54 on Tue, 1 Jul 2014 06:44:42 AM

This content downloaded from 119.226.90.54 on Tue, 1 Jul 2014 06:44:42 AM

Significant at the 10% level.

Significant at the 10% level

This content downloaded from 119.226.90.54 on Tue, 1 Jul 2014 06:44:42 AM

The Journal of LAW & ECONOMICS

This content downloaded from 119.226.90.54 on Tue, 1 Jul 2014 06:44:42 AM

This content downloaded from 119.226.90.54 on Tue, 1 Jul 2014 06:44:42 AM

Significant at the 10% level.

Asset Sales Require

The Journal of LAW & ECONOMICS

This content downloaded from 119.226.90.54 on Tue, 1 Jul 2014 06:44:42 AM

This content downloaded from 119.226.90.54 on Tue, 1 Jul 2014 06:44:42 AM

The Journal of LAW & ECONOMICS

firms state of incorporation is positively correlated with the use of antitakeover

Subsidiary dividendrelated payments

Asset sales restriction

This content downloaded from 119.226.90.54 on Tue, 1 Jul 2014 06:44:42 AM

Asset sales require