The purpose of this paper is to investigate whether initial technical debt covenant violations are associated with significant increases in the equity risk of violating firms. Our results indicate that first-time violations are associated with significant increases in both systematic and unsystematic risk. The increase in systematic risk is attributable primarily to rising levels of financial leverage as opposed to changes in the underlying asset beta. We also find that the change in unsystematic risk experienced by first-time debt covenant violators is a significant predictor of future exchange delisting, even after controlling for other factors typically associated with increasing financial distress.
Blackwell Publishers Ltd.
Fargher, N.L., Wilkins, M.S., & Holder-Webb, L.M. (2001). Initial technical violations of debt covenants and changes in firm risk. Journal of Business Finance & Accounting, 28(3-4), 465-480. doi: 10.1111/1468-5957.00381
Journal of Business Finance & Accounting