Structure and Determinants of Financial Covenants in Leveraged Buyouts - Evidence from an Economy with Strong Creditor Rights

This paper provides a detailed view of the structure and determinants of financial covenants in leveraged buyouts (LBOs). Our analysis is based on the proprietary credit documentation of 130 LBOs from Germany, an institutional setting with strong creditor rights where financial covenants are subject to rigorous ex-ante negotiations. The sample includes 23 (66) lead arrangers (private equity sponsors) who largely act on an international basis. We first analyze the covenant structure in sponsored loans relative to a benchmark of non-sponsored loans. We find that the covenant structure is more standardized in sponsored than in non-sponsored loans: the former show less variation in the included types and combinations of covenants and include more financial ratios than the latter. Second, we analyze covenant restrictiveness directly with proprietary headrooms, i.e. the distance between covenant thresholds and financial forecasts. Two competing arguments have economically large effects on the leverage covenant headroom in sponsored loans. On the one hand, reduced information asymmetry costs due to more frequent and larger in scale interactions of private equity investors with the lending market lead to less restrictive covenants for sponsored loans. But on the other hand, higher financial risk due to increased leverage levels lead to more restrictive covenants for sponsored loans.     «

This paper provides a detailed view of the structure and determinants of financial covenants in leveraged buyouts (LBOs). Our analysis is based on the proprietary credit documentation of 130 LBOs from Germany, an institutional setting with strong creditor rights where financial covenants are subject to rigorous ex-ante negotiations. The sample includes 23 (66) lead arrangers (private equity sponsors) who largely act on an international basis. We first analyze the covenant structure in sponsored...     »