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Does performance-sensitive debt mitigate debt overhang?

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  • Bensoussan, Alain
  • Chevalier-Roignant, Benoît
  • Rivera, Alejandro

Abstract

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.

Suggested Citation

  • Bensoussan, Alain & Chevalier-Roignant, Benoît & Rivera, Alejandro, 2021. "Does performance-sensitive debt mitigate debt overhang?," Journal of Economic Dynamics and Control, Elsevier, vol. 131(C).
    • Handle: RePEc:eee:dyncon:v:131:y:2021:i:c:s016518892100138x
    DOI: 10.1016/j.jedc.2021.104203
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