Event Risk Covenants

Merger and acquisition activities can have a strong impact on the capital structure ofthe companies involved and therefore on the value of debt. This paper discusses therole of covenants within debt contracts. Using the Real Option approach to quantifythe implications of covenants on the value of the company, it can be shown that covenantsdo not necessarily reduce the risk of debt lender. The value of the company isdetermined by assets in place and management decisions in the future. Any limitationof the management might reduce the value of the company and therefore the value ofdebt.