In this paper, we investigate the association between the purpose of a loan and the type of debt covenants, separated into balance-sheet-based and income-statement-based covenants. We use private loan deal observations obtained from the DealScan database over the period between 1996 and 2013. We classify our sample loan deals into three categories based on the purpose of borrowing, namely borrowings for corporate daily operating purposes, financing purposes, and acquisition and investing purposes. Our results provide evidence that the purpose of the loan is significantly associated with the type of debt covenants, suggesting that the lender and the borrower have considered the loan purpose when structuring their debt agreements. More specifically, the results indicate that the loans borrowed to fund acquisitions or long-term investment projects are more likely to have income-statement-based covenants, and less likely to have balance-sheet-based covenants. In contrast, the loans borrowed for corporate daily operating purposes or financing purposes are more likely to contain balance-sheet-based covenants relative to income-statement-based covenants.

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Copyright © 2019. Emerald Group Publishing. Article first published online: 14 MAY 2019.

DOI: 10.1108/RAF-10-2017-0194

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