The Resolution of Technical Default

Although costs of default underpin the debt covenant hypothesis, prior research provides limited evidence of their nature, magnitude, and impact on shareholder wealth. We show that announcements of technical default are associ ated with significant stock price declines. Combining post-default changes in terms of debt contracts with stock returns, we examine whether the consequences arising from renegotiation of lending agreements are priced in the market, and estimate that higher costs of borrowing and new restrictions on firms' opportunities impose wealth losses of 1.4% on shareholders. Leverage measures, frequently used in accounting research as proxies for economic effects of debt contracts, are found to be poor surrogates for default or renegotiation costs.