Performance Pricing in Debt Contracts

33 Pages Posted: 18 Jan 2001

See all articles by Anne Beatty

Anne Beatty

Ohio State University (OSU) - Department of Accounting & Management Information Systems

Joseph Weber

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Date Written: November 3, 2000

Abstract

In this paper we examine the decision to include performance pricing in lending contracts and we examine how that decision affects the spread that is charged on the loan. We find that contracts are more likely to include this feature when moral hazard costs are expected to be higher, uncertainty about changes in borrower credit risk is greater, managers willingness to bear increased risk is lower, adverse selection problems are larger, and when there are likely to be more renegotiation costs. Consistent with performance pricing reducing these problems, we find that after controlling for a selectivity correction and other factors known to affect loan spreads, the spread charged on a loan is 117 basis points lower when the price of the loan varies with the performance of the borrower. These results suggests that performance pricing provides a mechanism in addition to other contract features, such as covenants and loan maturity, that can be used to address some of the problems associated with debt.

Keywords: accounting, debt, leverage, performance, prcing, interest rate, default, accounting choice, Watts, Zimmerman, earnings management, earnings, efficient contracting, contracting, positive accounting

JEL Classification: G21, G30, G39, M41, M43

Suggested Citation

Beatty, Anne L. and Weber, Joseph Peter, Performance Pricing in Debt Contracts (November 3, 2000). Available at SSRN: https://ssrn.com/abstract=249172 or http://dx.doi.org/10.2139/ssrn.249172

Anne L. Beatty (Contact Author)

Ohio State University (OSU) - Department of Accounting & Management Information Systems ( email )

2100 Neil Avenue
Columbus, OH 43210
United States

Joseph Peter Weber

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street
E62-416
Cambridge, MA 02142
United States
617-253-4310 (Phone)

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