The Value of Restrictive Covenants in the Changing Bond Market Dynamics Before and After the Financial Crisis

We examine the pricing of restrictive covenants on bond issues before and after the financial crisis. The existing literature in this area uses data from the pre-crisis period. While the results of our analysis using pre-crisis data are entirely consistent with existing literature, there are dramatic differences in the value of restrictive covenants between the two periods. Further, the differences between the coefficients on the control variables document and elucidate the very different bond market dynamics before and after the crisis. Before the financial crisis, we find a statistically significant cost reduction of around 50 basis points for the inclusion of negative pledges and restrictions on sale-and-leaseback activity. In the post-financial crisis period, however, the benefit of these types of covenants evaporates, becoming statistically insignificant. The benefits, for investment grade firms, of restrictions on investment activities survives the financial crisis; the price effect in the pre-crisis period is a statistically significant 60 to 72 basis point (depending on model) reduction in yields, while in the post-crisis period it is a statistically significant 51 to 55 basis point reduction in yields. For non-investment grade firms, we find in the pre-crisis period that the price effect of restrictions on payouts and additional debt are insignificant. After the financial crisis, however, these restrictions lead to a statistically significant 141 to 150 basis point reduction in yields.