Costs of Performance Pricing Loans
49 Pages Posted: 9 Nov 2011
Date Written: October 11, 2011
We examine how monitoring costs and costs of financial distress affect the use of performance pricing provisions in bank loan contracts. We find that firms that are easier to monitor, such as those with better accounting quality, lower information opacity, or a stronger prior relationship with the lender are more likely to have performance pricing loans. The likelihood of using performance pricing is significantly reduced after financial restatement events. Conditional on using performance pricing loans, firms with lower (higher) accounting quality are more likely to have credit rating (accounting) based performance pricing loans. Finally, we find that the use of performance pricing decreases in the likelihood of financial distress. Our results are robust to various alternative measures of accounting quality, information opacity, as well as default risk. Our results are consistent with the notion that the quality of accounting information has a significant influence on the design of financial contracts.
Keywords: Performance pricing, accounting quality, information opacity, default risk, debt contracting
JEL Classification: G21, G32
Suggested Citation: Suggested Citation