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On the Pricing of Performance Sensitive Debt

Author

Listed:
  • Mjøs, Aksel

    (Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration)

  • Myklebust, Tor Åge

    (Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration)

  • Persson, Svein-Arne

    (Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration)

Abstract

Performance sensitive debt (PSD) contracts link a loan's interest rate to a measure of the borrower's credit relevant performance, e.g., if the borrower becomes less credit worthy, the interest rate increases according to a predetermined schedule. We derive and empirically test a pricing model for PSD contracts and find that interest increasing contracts are priced reflecting a substantial risk of shocks to borrower credit quality. Borrowers using such contracts are of an overall higher credit quality compared to borrowers using interest decreasing contracts. These contracts are priced as if no risk of shocks to borrower credit quality is present.

Suggested Citation

  • Mjøs, Aksel & Myklebust, Tor Åge & Persson, Svein-Arne, 2011. "On the Pricing of Performance Sensitive Debt," Discussion Papers 2011/5, Norwegian School of Economics, Department of Business and Management Science, revised 07 May 2012.
    • Handle: RePEc:hhs:nhhfms:2011_005
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    File URL: http://hdl.handle.net/11250/164024
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    References listed on IDEAS

    as
    1. von Thadden, Ernst-Ludwig, 2004. "Asymmetric information, bank lending and implicit contracts: the winner's curse," Finance Research Letters, Elsevier, vol. 1(1), pages 11-23, March.
    2. Mjøs, Aksel & Persson, Svein-Arne, 2010. "Level-Dependent Annuities: Defaults of Multiple Degrees," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 45(5), pages 1311-1339, October.
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    Cited by:

    1. Sarkar, Sudipto & Zhang, Chuanqian, 2015. "Underinvestment and the design of performance-sensitive debt," International Review of Economics & Finance, Elsevier, vol. 37(C), pages 240-253.

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    More about this item

    Keywords

    Performance sensitive debt; cash flow ratios; credit ratings;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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