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"The forecasting use of EBITDA covenants by equity investors" - by Dr. Alvis Lo

Publishing Date: 06/07/2018      (Last Update: 06/07/2018)

Accounting & Law Seminar

Speaker:

Dr. Alvis Lo
Associate Professor of Accounting
Boston College

 

 

 

Event Details

DateFriday, 13 July 2018
Time2:30 p.m. — 4:00 p.m.
Venue1303, K.K. Leung Bldg

Abstract:

Covenants are traditionally viewed as contractual devices used by banks to monitor borrowers. We examine whether covenants can also be used by equity investors outside of loan contracts to forecast future borrower performance. Using analysts to proxy for investors’ behavior, we find that analysts pay particular attention to covenants set on borrower EBITDA. Analysts treat EBITDA covenants as implicit forecasts of borrower performance and revise their expectations to move closer to the EBIDTA covenant threshold. Specifically, analysts revise their outstanding forecasts upward when the forecasts fall below the threshold and downward when they are well above it. These revisions result in more accurate forecasts. Beyond analyst forecasts, we also find a reduction in information asymmetry around loans with EBITDA covenants, consistent with the idea that investors can use EBITDA covenants to better predict borrower performance. Overall, we highlight a new and perhaps unintended use of EBITDA covenants by equity investors.