Measuring the probability of financial covenant violation in private debt contracts

•We specify covenant definitions using Compustat data that minimize measurement error for all individual Dealscan covenants.•We use these definitions to create a measure of aggregate probability of covenant violation.•We provide evidence that our aggregate probability measure is superior to alternatives used in prior literature.

We measure the probability that a borrower will violate financial covenants in private debt contracts. We analyze hand-coded data and specify standard covenant definitions using Compustat data that minimize measurement error for all individual Dealscan covenants. We use these definitions to create a measure of aggregate probability of violation, which can be used across all covenants in a loan or among covenant subsets of interest. We provide evidence that our aggregate probability measure is superior to alternatives used in prior literature.