The Impact Of Debt Covenants On Cross-sectional Equity Returns

The terms of the bond contract are a precondition for the behavior of shareholders and executives and the protection of the future interests of investors,which has been closely watched since the 1970s.Covenants exist in a company bond in the form of text,and binding the debtors and creditors' rights and obligations of both parties,and restrict the debtor to grab a series of terms and creditors,etc.Covennants and conditions of main function is to alleviate the information asymmetry between the debtor and creditor,to solve the conflict of interest between the debtor and creditor,to protect the interests of creditors in informational disadvantage.But existing research are focus on debt contracts clauses influence on the bond market,only a few scholars have focused on the effects of the debt contract terms and conditions of the stock market,By restricting the risk of the company's shareholders and administrators,the bond contract will affect the company's stock cross-section return,so we walked along the previous scholars study footprint,moving to a new direction for exploration and innovation.On the basis of the existing research literature,this paper puts forward five theoretical assumptions,The empirical analysis is based on the zero investment portfolio,by quantifying the covenants of the corporate bonds,the paper constructs the protection index of the bond contract covenants that measure the protection level of the bond contract terms,and put it through tierce into including three levels,based on this,longing the low bond protection index of companies and shorting the high bond protection index of companies,so a zero investment portfolio strategies are constructed,After using four different risk factors pricing model of regress the expected return of zero-investment portfolio to get the impact of debt covenants on cross-sectional equity returns,one assumption is verified successfully,compared to the firms with high debt covenants protection index level,the low bond covenants protection index instead will perform at.a higher level of company stock expected return.This is because if the company is in low bond covenants protection index level,the company shareholders take adventures to invest in some risk project,which will lead to the result of the companies will face more risk,according to the risks and benefits into positive correlation,so the cross-sectional equity returns of company will be higher.In addition,through the empirical study,this paper also proves the bond covenants to prevent the uncertainties of the company in the future,can reduce the credit risk faced by companies and can relieve the benefit conflicts between creditors and shareholders.Through the research of the impact of debt covenants on coss-sectional equity returns,first of all shareholders and creditors can be more clearly understand the potential close relation about them,the design is conducive to shareholders and creditors,while maximizing shareholders' interests will also protect the interests of the creditors,realize the win-win and mutual benefit,and then promote the development of the capital market,the second,bond covenants restrict the company shareholders and management,and effectively solve the problem of benefit conflict between shareholders and creditors.Experience conclusion in this paper,combined with the current situation of the development of China's corporate bond market,but also for China's bond market infrastructure and complete system provides many policy suggestions,in order to promote our country's bond market,especially the corporate bond market steady development.