Firm Characteristics and the Presence of Event Risk Covenants in Bond Indentures

Event risk covenants (ERCs) became popular as a bondholder protection measure during the height of restructuring activities in the 1980s. We investigate the empirical relation between firm characteristics and the likelihood of ERCs in bond indentures. In particular, we examine whether a firm's agency costs of debt, financial distress costs, and/or takeover potential influence its decision to include ERCs. Employing bonds with and without ERCs issued during 198S90, we provide evidence that the likelihood a firm will include ERCs is positively related to the firm's agency costs of debt and to its potential for takeover. The results however, do not support the financial distress costs hypothesis.