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Recovery Rates and Macroeconomic Conditions: The role of loan covenants

by Zhipeng Zhang of Boston College

September 2, 2009

Abstract: For U.S. firms from 1988 to 2007, firms with stricter loan covenants had higher firm-level default recovery rates. Covenants were stricter, moreover, when set during downturns in the business cycle. This implies a negative dependence of recovery rates on lagged macroeconomic conditions. That is, bank loan contracts established in economic recessions have tight covenants, leading later to higher recovery rates. My empirical evidence suggests that private creditors have significant influence on firms' bankruptcy decisions through the channel of covenants in debt contracts.

JEL Classification: G33, G13, E32, G21.

Keywords: Recovery rate, Bankruptcy, Loan covenant, Creditor control, Business cycle.

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