Structure and determinants of financial covenants in leveraged buyouts

The authors use proprietary loan contracts and financial information negotiated between banks and private equity sponsors to explore the financial covenant structure and the determinants of covenant restrictiveness in a large set of leveraged buyouts. With respect to the covenant structure, we analyze the utilized types of financial covenants in sponsored loans and in comparable nonsponsored loans, such as highly levered term loans or loans used toward M&A. The authors find that sponsored loans show less variation in the included types and combinations of covenants and include more financial covenants than the comparable nonsponsored loans. With respect to covenant restrictiveness, the authors measure precisely the distance between threshold and financial forecast. They show that two competing mechanisms, reduced information asymmetry costs and increased financial risk, affect the restrictiveness in sponsored loans.