Syndicated Loans : The Role of Covenants in Mitigating Lender Disagreements

We study the role of covenants in syndicated bank loans. We argue that, in addition to being a device for monitoring the borrower, covenants can help mitigate conflicts of interest between the lead-arranger and participating banks in the syndicate. Such disagreements can arise when, for instance, a lead-arranger has the incentive to support a poorly performing borrower and offer loan modification – while other syndicate lenders do not. We develop a simple model and find empirical support for its predictions that covenants are less likely to be present: (i) in non-syndicated versus syndicated loans; (ii) when the lead's loan allocation is greater and (iii) when participating bank affiliates hold substantial equity in the borrower. Consistent with this evidence, we find that lead arrangers are more likely to syndicate with banks that hold borrower equity through affiliated entities