Renegotiation Costs and Contract Design

61 Pages Posted: 7 Jun 2017 Last revised: 29 Mar 2021

See all articles by Scott Dyreng

Scott Dyreng

Duke University - Accounting

Elia Ferracuti

Duke University - Fuqua School of Business

Arthur Morris

Hong Kong University of Science & Technology (HKUST) - Department of Accounting

Date Written: March 29, 2021

Abstract

We examine the relation between the cost of debt contract renegotiation and contract design. We use an exogenous shock to the cost of renegotiation to show that as renegotiation costs decline, the maturity of debt contracts lengthens, the initial likelihood of covenant violation increases, and the use of performance pricing provisions becomes less frequent. The evidence indicates that ex-ante allocation of cash flow rights and ex-post reallocation of decision rights through renegotiation are local substitutes, where the preference for one mechanism versus the other depends, at least in part, on renegotiation costs. We also show that the characteristics of contracts that are unaffected by the exogenous shock we examine do not change, suggesting the effects we document are not spurious time trends.

Keywords: Debt Contracts, Renegotiation Costs, TD9599

JEL Classification: G32, G33, G38

Suggested Citation

Dyreng, Scott and Ferracuti, Elia and Morris, Arthur, Renegotiation Costs and Contract Design (March 29, 2021). 28th Annual Conference on Financial Economics and Accounting, Paris December 2017 Finance Meeting EUROFIDAI - AFFI, Available at SSRN: https://ssrn.com/abstract=2981069 or http://dx.doi.org/10.2139/ssrn.2981069

Scott Dyreng (Contact Author)

Duke University - Accounting ( email )

Box 90120, Fuqua School of Business
Durham, NC 27708-0120
United States

Elia Ferracuti

Duke University - Fuqua School of Business ( email )

Box 90120
Durham, NC 27708-0120
United States
919-660-1974 (Phone)

Arthur Morris

Hong Kong University of Science & Technology (HKUST) - Department of Accounting ( email )

Clear Water Bay
Kowloon
Hong Kong

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