Corporate Acquisitions Around Time Periods of Loan Covenant Violations

We present empirical evidence on acquirer firms that have violated or are about to violate a loan covenant within four quarters of undergoing an acquisition. We find that firms that violate a covenant within the four quarters before the acquisition announcement have the highest announcement period abnormal returns, while firms that violate a covenant within the four quarters after the acquisition announcement but not within the four quarters before it have the sharpest decline in abnormal returns after the acquisition announcement. Also, firms that violate or are about to violate a loan covenant within four quarters have a significantly lower mean target firm deal size than those that have not violated covenants within those time periods. Such results indicate that when firms violate or are about to violate a loan covenant, corporate governance shifts in power cause creditors to enforce stricter rules on management’s actions, making sure that the acquisitions that management pursues adds to firm value.