Covenants restricting additional borrowings primarily protect the:
A)shareholders' residual interests in the firm.
B)debtholders from the added risk of dilution of their claims.
C)debtholders from changes in market interest rates.
D)managers by avoiding agency costs.
E)shareholders from agency costs.

Question

Quizplus · Accepted Answer

Covenants restricting additional borrowings are put in place to protect debtholders from the added risk of dilution of their claims. If a company takes on additional debt, it increases the risk to existing debtholders and reduces their relative seniority in the event of default. Restricting additional borrowings helps to limit this risk for debtholders.

Covenants Restricting Additional Borrowings Primarily Protect The