Jurnal of Finance - Do Creditor Rights Increase Employment Risk? Evidence from Loan Covenants
ANTONIO FALATO,NELLIE LIANG
ABSTRACT
Using a regression discontinuity design, we provide
evidence that there are sharp and substantial employment cuts following loan
covenant violations, when creditors gain rights to accelerate, restructure, or
terminate a loan. The cuts are larger at firms with higher financing frictions
and with weaker employee bargaining power, and during industry and
macroeconomic downturns, when employees have fewer job opportunities. Union
elections that create new labor bargaining units lead to higher loan spreads,
consistent with creditors requiring compensation when employees gain bargaining
power. Overall, binding financial contracts have a large impact on employees
and are an amplification mechanism of economic downturns.
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