Performance-Sensitive Debt – The Intertwined Effects of Performance Measurement and Pricing Grid Asymmetry
44 Pages Posted: 9 Oct 2014
Date Written: September 8, 2014
This paper studies the use of performance pricing (PP) provisions in debt contracts and compares accounting-based with rating-based pricing designs. We find that rating-based provisions are used by volatile-growth borrowers and allow for stronger spread increases over the credit period. Accounting-based provisions are employed by opaque-growth borrowers and stipulate stronger spread reductions. Further, a higher spread-increase potential in rating-based contracts lowers the spread at the loan’s inception and improves the borrower’s performance later on. In contrast, a higher spread-decrease potential in accounting-based contracts lowers the initial spread and raises the borrower’s leverage afterwards. The evidence indicates that rating-based contracts are indeed employed for different reasons than accounting-based contracts: the former to signal a borrower’s quality, the latter to mitigate investment inefficiencies.
Keywords: performance pricing, performance-sensitive debt, accounting data, credit ratings, underinvestment, collateral
JEL Classification: G30, M40
Suggested Citation: Suggested Citation