Pros And Disadvantages Of Debt Covenants

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Debt Covenants
Restrictions that are put on a borrower by the bank or other entity that granted the loan. The restrictions might specify that a certain level of sales or profits be generated or might limit the company’s ability to take on other debt. If debt covenants are broken, often the loan becomes due immediately. They can be either “restrictions placed on a borrowing firm’s activities (restrictive covenants) for example limitations on the payment of dividends or for additional borrowing, requirements for the borrowing firm to carry out specific actions (affirmative covenants)” Shivakumar (2013), for example the regular submission of some financial statement that are audited, or the maintenance of a certain amount of working capital.
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Conducting, supervising or managing something, the careful and responsible management of something entrusted to one’s care.

This paper examines the role that financial reporting plays in the contracts that have the purpose to mitigate the gap between managers and shareholders and managers and debt holders. It also elaborates on the way that financial reports are used in debt and stewardship contracting. It also examines the advantages and disadvantages of conservatism and fair value accounting in the debt and stewardship contracts.
Contracts are now more than ever widely used due to the agency problems facing the firms.
Myers (1977) points out that “equity holders have an incentive to underinvest and pass up positive net present value (NPV) projects when a firm has risky debt outstanding”
Many research papers have elaborated on the topic of agency costs such as Hermalin and Weisbach 2003, and many others on the role and importance of contracts in the firm environment. (Roberts and Sufi 2009a).
Especially on the last decade, primarily due to the high availability of datasets with detailed data regarding debt covenants, credit default spreads and bond prices for a large number of both private and public firms and varied industry

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