The Influence of the Organizational Life Cycle on the Violation of Financial Covenants

Abstract

Purpose

To investigate how the stages of the organizational life cycle influence the probability of violation of financial covenants.

Theoretical framework

Companies in different stages of the organizational life cycle present different incentives when assuming a position regarding profitability, investment, dividend distribution, the evolution of sales, indebtedness, strategic planning, information disclosure, and earnings quality, and these factors are directly related with the inclusion and violation of financial covenants in debt contracts.

Design/methodology/approach

We used 1,328 observations of 197 non-financial Brazilian companies listed on the B3 in the period from 2010 to 2018. The accounting data were collected from the Economatica database and the financial covenant information was obtained from analyzing more than 2,400 company footnotes. To analyze the results, we used logistic regressions with year-controlled data.

Findings

The results highlight that companies in the maturity stage present a lower probability of violating some limit stipulated in the financial covenants in their debt contracts than companies in the other stages, that is, introduction, growth, turbulence, or decline.

Practical & social implications of research

In regulatory terms, the results presented further reinforce the need to revise CPC 26 (R1), making it obligatory to disclose the limits of restrictive clauses in explanatory notes for corporations.

Originality/value

These results extend the literature by presenting evidence that it is not only the turbulence and decline phases that cause operational risks that can culminate in an increased probability of violation of financial covenants, but also the initial introduction and growth phases of companies.

Keywords:
Financial covenants; organizational life cycle stages; violation of covenants