Product Market Threats and Performance-Sensitive Debt
50 Pages Posted: 19 Mar 2014 Last revised: 13 Feb 2021
Date Written: September 16, 2018
Abstract
This paper examines how product market threats shape the use of performance pricing in loan contracts. Loan contracting faces a trade-off between financial markets and product markets: while using contractual terms that are linked to borrower performance -- such as performance pricing -- mitigates borrower-creditor frictions in financial markets, it makes a borrower vulnerable to product market pressures, which often decline borrower performance and make performance pricing more likely to become binding. Supporting this trade-off, we find that product market threats significantly moderate the use of performance pricing in loan contracts, particularly when the benefit of doing so outweighs its cost in exacerbating borrower-creditor frictions in financial markets
Keywords: product market threats, financial markets, loan contracting, performance-sensitive debt, performance pricing
JEL Classification: G20, G21, G30, G32, L10, L20
Suggested Citation: Suggested Citation
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