The impact of simultaneous holdings of equity and debt on financial covenants in debt contracts

The purpose of this study is to examine the effects of non-commercial banking institutions’ simultaneous holdings of equity and debt in the same firm (hereafter, dual holdings) on financial covenants in debt contracts.

By using the DealScan database, this study tests how dual holdings affect the number of financial debt covenants.

This study finds that the presence of dual holders is positively associated with the number of financial covenants in general, suggesting that the use of financial covenants is reduced when the interests between shareholders and creditors are aligned. This study also finds that dual holder participation does not reduce the number of financial covenants in leveraged loans as much as it does in investment-grade loans. Additionally, when a dual holder has a large portion of equity stakes and loan claims in a borrowing firm, the effect of dual holdings on financial covenants is more pronounced.

This study contributes to debt market research by showing that dual holder participation reduces the number of financial covenants in debt contracts.