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The influence of covenant protection on yield of corporate bond

Vol. 21, Iss. 7, FEBRUARY 2015

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Available online: 9 February 2015


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Pages: 34-44

Zadorozhnaya A.N. Omsk State Transport University, Omsk, Russian Federation

The article presents the results of empirical study of how covenant protection affects the cost of debt. Covenants can mitigate risk-shifting problem in agency conflicts, but also they may influence on corporate financial policy by reducing the cost of debt. The aim of the study is to test the costly contracting hypothesis (CCH) both in domestic corporate bond market and in Eurobond market. The extant research on agency theory of covenants (ATC) relies on the data from the US and other developed countries. Due to the fact that the institutional environment affects the nature of financial contract, it is necessary to extend empirical evidence from developing markets. The hypothesis is tested with regression models using ordinary least squares (OLS) and fixed effect regression. The study is based on panel data. The sample is formed by data for 200 Russian public nonfinancial companies that place bonds both in domestic and Eurobond market during 2008-2013. The obtained research results demonstrate that a negative relation between offering yield and the presence of covenants which is consistent with the costly contracting hypothesis (CCH) is registered only in Eurobond market. These results suggest some policy implication. Covenant provisions included in indenture agreements should be tailored to take into account firms' and issues' characteristics. Analysis of covenant protection contained in bond indentures could be included as a criteria in credit rating assessment.

Keywords: agency theory, debtholder-shareholder conflict, covenants, costly contracting hypothesis


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