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Department of Business and Management Science, Norwegian School of Economics (NHH) Discussion Papers, Department of Business and Management Science, Norwegian School of Economics (NHH)

No 2011/5:
On the Pricing of Performance Sensitive Debt

Aksel Mjs (), Tor ge Myklebust () and Svein-Arne Persson ()

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.

Keywords: Performance sensitive debt; cash flow ratios; credit ratings; (follow links to similar papers)

JEL-Codes: G12; G32; (follow links to similar papers)

69 pages, March 31, 2011, Revised May 7, 2012

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