Shock amplification from loan covenants

In this project, I aim to analyze the impact of financial "covenants" or contract clauses at the macro level. Using publicly available data from US firms, I demonstrate how a firm that is in violation of a covenant (of any type) during a recession will tend to decrease their number of employees and amount of investment more than other firms while in normal times no difference will be observed. The theoretical model (work in progress) shows that banks use covenants on a firm's income both as a predictor of the firm's future performance and as an option to decrease the amount of credit issued during a recession. An innovative aspect of this project is to combine both financial constraints on equity and constraints on firm revenues. This combination is interesting because it would potentially shed light on new mechanisms of amplification of fundamental shocks.