Interest Rates and the Design of Financial Contracts

61 Pages Posted: 13 Jan 2020 Last revised: 6 May 2020

See all articles by Michael R. Roberts

Michael R. Roberts

The Wharton School - University of Pennsylvania; National Bureau of Economic Research (NBER)

Michael Schwert

University of Pennsylvania - The Wharton School

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Date Written: May 5, 2020

Abstract

We show that variation in short-term nominal interest rates produces an endogenous response in the design of and commitment to corporate loan contracts. Interest rates are inversely related to the cash flow rights and positively related to the control rights granted to creditors. An implication of this contractual response is a sharp increase in the ex post renegotiation of contracts originated in low interest rate environments, as well as a muted effect of interest rate variation on the cost of debt capital. Our findings illustrate how the design of financial contracts in practice reflects a multi-dimensional tradeoff among contract features that aligns incentives and apportions risk among the contracting parties in a state-contingent manner.

Keywords: financial contracts, interest rates, banking, commercial lending

JEL Classification: G21, G23, E43, E52

Suggested Citation

Roberts, Michael R. and Schwert, Michael, Interest Rates and the Design of Financial Contracts (May 5, 2020). Available at SSRN: https://ssrn.com/abstract=3508816 or http://dx.doi.org/10.2139/ssrn.3508816

Michael R. Roberts

The Wharton School - University of Pennsylvania; National Bureau of Economic Research (NBER) ( email )

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HOME PAGE: http://finance.wharton.upenn.edu/~mrrobert/

Michael Schwert (Contact Author)

University of Pennsylvania - The Wharton School ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

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