Heterogeneity of covenants violations and corporate financial behaviour

The purpose is to investigate how heterogeneous covenants and breaches, which are a source of uncertainty for firms, influence their heterogeneous capital structure behaviour. An innovative dataset is exploited combining Compustat data and EDGAR/SEC data scanned for US firms quarterly over the period 1981q1-2020q4. The textual analysis is implemented through a Python procedure dedicated to identifying covenants, breaches and consequences, and distinguishing between various types of maintenance and incurrence covenants. While maintenance covenants require continuous compliance, with the covenant threshold under the threat of transferring control rights to creditors, incurrence covenants preserve equity control rights but trigger pre-determined restrictions on the borrower's actions once the covenant threshold is exceeded. Two main hypotheses are tested. 1) Maintenance covenants represent a constraint that must be met every quarter, a constant threat that limits the most innovative investments and reorganizations. Therefore, if a firm follows a certain financial behaviour, e.g., a pecking order behaviour, maintenance covenants reinforce and stimulate this behaviour even more. 2) Incurrence covenants, on the other hand, only operate when the company wishes to take a certain action that triggers a check on contractual compliance. Incurrence covenants, therefore, may produce a shift from one financial behaviour to another.s.