Performance Pricing in Bank Debt Contracts

45 Pages Posted: 30 Sep 2004  

Paul Asquith

Massachusetts Institute of Technology (MIT) - Economics, Finance, Accounting (EFA); National Bureau of Economic Research (NBER)

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: July 2004

Abstract

Performance pricing links the interest rate spread on bank debt to a borrower's performance via two options. It gives borrowers an option to reduce interest rates if credit quality improves, and it gives lenders an option to receive higher interest rates if credit quality deteriorates. Contracts with interest-decreasing performance pricing are more common when prepayment is more likely or more costly and when adverse selection costs are higher, and are less common when multiple measures of performance are better predictors of credit quality. Interest-increasing performance pricing is more common when lenders offer reductions in interest rates to add this provision, when the probability of a downgrade is more likely, and when moral hazard costs are higher. This paper also finds that lenders charge a lower rate when interest-increasing performance pricing provisions are included in the contract.

Keywords: Accounting choice, leverage, performace, pricing, interest rate, earnings management, accounting, debt, default, earnings, efficient contracting, positive accounting

JEL Classification: G21, G30, G39, M41, M43

Suggested Citation

Asquith, Paul and Beatty, Anne and Weber, Joseph, Performance Pricing in Bank Debt Contracts (July 2004). Available at SSRN: https://ssrn.com/abstract=597701 or http://dx.doi.org/10.2139/ssrn.597701

Paul Asquith

Massachusetts Institute of Technology (MIT) - Economics, Finance, Accounting (EFA) ( email )

77 Massachusetts Avenue
Cambridge, MA 02139-4307
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Anne L. Beatty (Contact Author)

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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