Does Performance-Sensitive Debt Mitigate Debt Overhang?
50 Pages Posted: 15 Jan 2020 Last revised: 20 May 2021
Date Written: December 24, 2019
We model the expansion decision of a levered firm. Straight debt distorts both timing and scaling: the firm invests less and later than its all-equity financed counterpart. The inclusion of performance sensitivity in the debt contract mitigates such distortions. Moreover, performance sensitivity is consistent with firm value maximization within a standard trade-off theory of capital structure. As a result, our model rationalizes the widespread use of performance sensitive debt (PSD), especially amongst fast growth firms.
Keywords: Performance-Sensitive Debt, Real Options, Debt Overhang, Capital Structure
JEL Classification: G30
Suggested Citation: Suggested Citation