Renegotiation Costs and Contract Design
61 Pages Posted: 7 Jun 2017 Last revised: 29 Mar 2021
Date Written: March 29, 2021
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: Suggested Citation