Price Uncertainty and Debt Covenants: Evidence from U.S. Oil Producers

We use an exogenous, forward-looking measure of price uncertainty to examine the effect of uncertainty on the use of covenants in private and public debt contracts. The effect of uncertainty differs significantly in loans versus bonds, suggesting that private and public lenders face different incentives when contracting under high uncertainty. In loans, uncertainty increases the use of performance-based covenants. In contrast, covenant usage decreases in bonds, but firms with low agency conflicts mainly drive this effect. However, bondholders require higher spreads to offset the lack of protection with fewer covenants. Hedging does not affect the covenant-uncertainty relationship for debt contracts.