Debt covenant violations and corporate cost management

Abstract

In this study, we examine whether and how debt covenant violations are related to corporate cost management, an important business operating decision. Our findings suggest that firms significantly reduce slack operating resources after debt covenant violations. Our cross-sectional tests indicate that this reduction in cost stickiness is more pronounced when creditor monitoring is stronger, and when empire building is more severe. Our evidence adds to the literature on determinants of corporate cost management and sheds new light on how creditors influence firm behavior.