Research

Working Papers

"Loan Covenants and Information Quality" (Job Market Paper)

What determines whether a firm borrows with or without financial covenants? This paper addresses this question from both theoretical and empirical angles. Using a novel manually collected loan dataset, I compare the characteristics of small to medium-sized public firms that borrow without financial covenants to those that borrow with financial covenants. Firms that issue loans without financial covenants tend to have lower accounting quality, lower assets, and are experiencing faster growth in profitability relative to firms that issue loans with financial covenants. To understand a firm's trade-off to borrow with or without a covenant, I build a theoretical model of project financing in which there is noisy public information about the project's profitability, and the lender can privately monitor to improve the information quality. I show that if the signal precision without monitoring is sufficiently low (high), the equilibrium contract does not include (includes) a covenant. Covenant inclusion plays a key role in providing incentives to the lender to monitor. I show that the lender monitors less often relative to the first best. Insufficient monitoring leads to "excessive risk taking,'' namely, bad quality firms continuing with the project too often. I explore cross-sectional implications of the model and show that they are consistent with the data.

"Litigation, Holdout Creditors, and Sovereign Debt Renegotiation" (Paper)

In sovereign debt renegotiations, there has been a growing number of incidents where creditors holdout on settlement and litigate against defaulting countries. This paper studies equilibrium consequences of holdouts in renegotiation by modeling creditors' decision to holdout and litigate against a country. Creditors decide whether or not to holdout based on the probability of successful litigation and their idiosyncratic cost of holding out. I solve the model numerically and compare equilibria with holdout creditors (corresponding to a positive probability of winning) to those without holdout creditors (corresponding to a zero probability of winning). I show that given a sufficiently high probability of winning and/or a high enough defaulted debt, the presence of the holdout creditors increases the expected debt recovery rate, which makes the default option less attractive, and decreases the country's default probability and the interest rate on the country's debt. The country responds by borrowing more but defaults less often along the equilibrium path as it wants to avoid default and facing holdout creditors. Having a non-zero probability of successful litigation is welfare improving for the country as it sustains higher debt and defaults less frequently.