Firm Size, Insider Ownership, And Accounting-Based Debt Covenants

Abstract

The objective of this study is to investigate the separate and joint effects of firm size and insider ownership on the types of debt covenants required by creditors. An economic argument is developed to predict the types of covenants that will be required by creditors of firms of different sizes and with differing levels of insider ownership. The main finding is that creditors of small, high-insider-ownership firms demand liquidity covenants as protection against wealth transfers. An additional finding is that creditors of large firms demand covenants based on tangible assets, regardless of the level of insider ownership. The main conclusion is that the specific types of debt covenants required by creditors depend on creditors expectations concerning the effects of size and insider ownership on management actions.