Debt Contracting When Borrowers Face Transitory Uncertainty: Evidence from U.S. Gubernatorial Elections

43 Pages Posted: 31 Jul 2019 Last revised: 7 Oct 2021

See all articles by Kirak Kim

Kirak Kim

University of Bristol - School of Economics Finance and Management

Trang Nguyen

University of Glasgow

Date Written: September 2021

Abstract

We show that policy uncertainty surrounding U.S. gubernatorial elections has an important impact on loan pricing that can go unnoticed. In gubernatorial election years, loan contracts are more likely to include performance-pricing provisions, whereas loan spreads are mostly unaffected, consistent with efficiency of loan contracting under transitory uncertainty. Only among the loans without performance-pricing provisions, a marginal increase in loan spreads (1 to 4 bps) in election years and an increased demand for loan-spread amendments post-election are observed, suggesting that performance-pricing provision curbs an explicit rise in loan spreads. Furthermore, an important pricing effect is manifested through interest-rate contingencies in pricing grids. The use of rate-increasing grids rises in election years for the borrowers with geographically concentrated operations, high government contract-dependence, high political risk and high distress risk, indicating that loan contracts are designed to ensure compensation to lenders for uncertainty via interest-rate contingencies. Overall, our findings suggest that corporate borrowers facing election uncertainty make a dynamic tradeoff between a rise in the cost of loans at origination and the possibility of a cost increase in the future pursuant to state-contingent pricing rules.

Keywords: uncertainty, gubernatorial election, debt contract, contingency pricing, cost of capital

JEL Classification: G30, G39

Suggested Citation

Kim, Kirak and Nguyen, Trang, Debt Contracting When Borrowers Face Transitory Uncertainty: Evidence from U.S. Gubernatorial Elections (September 2021). Available at SSRN: https://ssrn.com/abstract=3427141 or http://dx.doi.org/10.2139/ssrn.3427141

Kirak Kim (Contact Author)

University of Bristol - School of Economics Finance and Management ( email )

12 Priory Road
Bristol, BS8 1TU
United Kingdom

Trang Nguyen

University of Glasgow ( email )

Adam Smith Business School
Glasgow, Scotland G12 8LE
United Kingdom

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