Lender Forbearance

We use a regression discontinuity design to study ex-post discretion in lender’s contractual enforcement of restrictive covenant violations. At pre-set thresholds, we find that lenders enforce contractual breaches at an 11% rate, varying between 5% and 18% and peaking when credit conditions are tightest, consistent with enforcement exacerbating credit cycles. Costly coordination reduces enforcement; increasing the number of lenders required to vote for enforcement action by one reduces the enforcement propensity by 6.3%. Enforcement is less frequent for borrowers with easy access to external financing and for well-reputed lead arrangers, suggesting that optimal enforcement depends on endogenous matching.