This paper investigates the effect of banking relationship on the likelihood of lenders' loan covenant violation enforcement. We find that if lenders have long-run relationship with borrowers, these lenders enforce material covenant violation at a substantially lower rate when borrowers breach financial covenants. Moreover, borrowers with such relationship are less likely to experience rises of loan interest rates and a deterioration of subsequent financing and investment activities when they fail to fulfil their financial covenants. Further evidence shows that the mitigation of information asymmetry along lending relationship, instead of alternative channels (e.g., soft-budget problem), is more likely to be the driving force of the empirical findings. Our results are also robust to several endogeneity concerns. 

JEL Classifications: G21, G32
Keywords: Bank relationship, Covenant violation, Loan renegotiation​