I investigate whether the impact of financial covenant violations on corporate financing policy varies across countries depending on differences in legal enforcement. Covenant violations trigger creditors to use their contractual acceleration and termination rights to increase interest rates or halt any further supply of credit. For a sample of 518 firms in 28 countries, I find that the presence of strong enforcement alleviates a reported decline in net debt issuance following a covenant violation by close to 10%. The results are robust to alternative specifications, the inclusion of a number of control variables and country characteristics, and the use of alternative proxies for legal enforcement and creditor rights. This paper identifies a novel channel, debt covenants, through which creditors respond to the contracting environment, and emphasizes the importance of legal enforcement to financing activity.

We investigate the impact of debt covenants on acquisition characteristics. We find that acquirers with covenants pay lower merger premiums, make more focused acquisitions, and engage in acquisitions with higher synergy gains and higher acquirer returns around deal announcement, relative to those without. All these results are more pronounced with stricter debt covenants. Additionally, acquirers with covenants pay with a lower share fraction. In particular, capital covenants, which restrict debt issuance, are positively related to the share fraction, while performance covenants, which affect the stock of equity capital, result in a lower share fraction of payment. All our results hold only for acquirers who have not violated covenants, reemphasizing the importance of debt covenants and the threat they entail on corporate policies even before nearing violation states. Results also, generally, hold for badly governed firms, suggesting that creditors' monitoring role through debt covenants and borrower's effective corporate governance are substitutes.