The market response to implied debt covenant violations

Previous research documents a negative stock price reaction to the announcement of debt covenant violations. I find evidence that investors price the likelihood of an earnings-based debt covenant violation on the date firms report earnings. Furthermore, I find no evidence of a negative stock price reaction to the announcement of an actual debt covenant violation when there was high likelihood of such a violation implied by previous reported earnings. My results suggest that the cost of debt covenant violations in the cross-section is higher than estimated in the previous literature