Syndicate Size and the Choice of Covenants in Debt Contracts

I investigate whether and how syndicate size influences the type of covenants used in debt contracts. Prior theory and evidence suggest that renegotiation considerations from coordination difficulties in large syndicates and intertemporal transfers due to relationship lending in small syndicates are factors in the design of covenants. I find that for large syndicates, borrowers and lenders avoid the use of flexibility-reducing covenants that are more likely to impact negatively on value-enhancing corporate policies (e.g., investments) in good states of the world. This effect becomes stronger when the borrower has fewer outside financing options. Additionally, I find that contracts with large syndicates are more likely to have more covenant slack, include performance pricing provisions, have tailored capital expenditure covenants that alleviate over- and under-investment problems, and principally rely on covenants that are directly linked to the current performance of the borrower. Collectively, these results imply that syndicate size and related renegotiation considerations affect how accounting information is used in debt contracts