The Journal of Finance

Do Creditor Rights Increase Employment Risk? Evidence from Loan Covenants

Published: 08/04/2016   |   DOI: 10.1111/jofi.12435

ANTONIO FALATO, NELLIE LIANG

Using a regression discontinuity design, we provide evidence that there are sharp and substantial employment cuts following loan covenant violations, when creditors gain rights to accelerate, restructure, or terminate a loan. The cuts are larger at firms with higher financing frictions and with weaker employee bargaining power, and during industry and macroeconomic downturns, when employees have fewer job opportunities. Union elections that create new labor bargaining units lead to higher loan spreads, consistent with creditors requiring compensation when employees gain bargaining power. Overall, binding financial contracts have a large impact on employees and are an amplification mechanism of economic downturns.

The Loan Covenant Channel: How Bank Health Transmits to the Real Economy

Published: 08/08/2021   |   DOI: 10.1111/jofi.13074

GABRIEL CHODOROW‐REICH, ANTONIO FALATO

We document the importance of covenant violations in transmitting bank health to nonfinancial firms. Roughly one‐third of loans in our supervisory data breach a covenant during the 2008 to 2009 period, allowing lenders to force a renegotiation of loan terms or to accelerate repayment of otherwise long‐term credit. Lenders in worse health are more likely to force a reduction in the loan commitment following a violation. The reduction in credit to borrowers who violate a covenant can account for the majority of the cross‐sectional variation in credit supply during the 2008 to 2009 crisis.

Fire‐Sale Spillovers in Debt Markets

Published: 09/14/2021   |   DOI: 10.1111/jofi.13078

ANTONIO FALATO, ALI HORTAÇSU, DAN LI, CHAEHEE SHIN

Fire sales induced by investor redemptions have powerful spillover effects among funds that hold the same assets, hurting peer funds' performance and flows, and leading to further asset sales with negative bond price impact. A one‐standard‐deviation increase in our fire‐sale spillover measure leads to a 45 (90) bp decrease in peer fund returns (flows) and a two percentage point increase in the likelihood of a large bond price drop. The results hold in a regression‐discontinuity design addressing identification concerns. Timing, heterogeneity, instrumental‐variable, and placebo tests further support the price‐impact mechanism. Model‐based counterfactual and stress‐test analyses quantify the financial stability implications.

Rising Intangible Capital, Shrinking Debt Capacity, and the U.S. Corporate Savings Glut

Published: 08/19/2022   |   DOI: 10.1111/jofi.13174

ANTONIO FALATO, DALIDA KADYRZHANOVA, JAE SIM, ROBERTO STERI

This paper explores the connection between rising intangible capital and the secular upward trend in U.S. corporate cash holdings. We calibrate a dynamic model with two productive assets—tangible and intangible capital—in which only tangible capital can serve as collateral. We highlight the following points: (i) a shift toward intangible capital shrinks firms' debt capacity and leads them to hold more cash, (ii) the effect accounts for three‐quarters of the observed trend in average cash ratios, and (iii) it also accounts for the upward trend of cash ratios in the cross‐section of small and large firms and in the aggregate.