The Role and Characteristics of Accounting-based Performance Pricing in Private Debt Contracts

41 Pages Posted: 15 Aug 2002  

Ilia D. Dichev

Emory University - Department of Accounting

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: June 2002

Abstract

Performance pricing is a recent contractual innovation, which ties interest rates to a pre-specified grid of some measure of credit risk. We investigate performance pricing because it is becoming a common feature in bank debt, and essentially represents a rare example of market pricing directly tied to accounting-based measures of performance. Our major findings can be summarized as follows. First, we argue that performance pricing emerged as a response to increasing competitive pressures in the market for corporate financing. It reduces transaction and agency costs, and allows for more efficient contracts, furthering the competitive appeal of bank debt. Second, accounting-based performance pricing provisions are detailed, sophisticated, and expansive. The typical pricing grid accommodates ranges of credit risk and interest rate changes, which seem large compared to the economics of private lending. Third, there is a strong pattern of complementarity between same-variable performance pricing and covenant provisions. Probing further, we find that the typical contract sets the initial pricing at the high-cost end of the performance grid, with a same-variable covenant set tightly beyond the top of the grid. Thus, performance pricing and covenants form a well-defined contractual package, where performance pricing provisions are typically designed to handle credit improvements, while credit deteriorations are handled with covenant provisions.

Keywords: performance pricing, bank debt, accounting ratios, debt/EBITDA

JEL Classification: G21, M41

Suggested Citation

Dichev, Ilia D. and Beatty, Anne and Weber, Joseph, The Role and Characteristics of Accounting-based Performance Pricing in Private Debt Contracts (June 2002). Available at SSRN: https://ssrn.com/abstract=318399 or http://dx.doi.org/10.2139/ssrn.318399

Ilia D. Dichev (Contact Author)

Emory University - Department of Accounting ( email )

1300 Clifton Road
Atlanta, GA 30322-2722
United States

Anne L. Beatty

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 )

77 Massachusetts Ave.
E62-416
Cambridge, MA 02142
United States
617-253-4310 (Phone)

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