Performance-Sensitive Debt – The Intertwined Effects of Performance Measurement and Pricing Grid Asymmetry

44 Pages Posted: 9 Oct 2014

See all articles by Christina E. Bannier

Christina E. Bannier

Justus-Liebig-University Giessen

M. Wiemann

Frankfurt School of Finance & Management

Multiple version iconThere are 2 versions of this paper

Date Written: September 8, 2014

Abstract

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

Bannier, Christina E. and Wiemann, M., Performance-Sensitive Debt – The Intertwined Effects of Performance Measurement and Pricing Grid Asymmetry (September 8, 2014). CFS Working Paper, No. 476. Available at SSRN: https://ssrn.com/abstract=2507707 or http://dx.doi.org/10.2139/ssrn.2507707

Christina E. Bannier (Contact Author)

Justus-Liebig-University Giessen ( email )

Licher Str. 62
Gießen, 35394
Germany
+49 641 99 22551 (Phone)

M. Wiemann

Frankfurt School of Finance & Management ( email )

Sonnemannstraße 9-11
Frankfurt am Main, 60314
Germany

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