Performance Pricing in Bank Debt Contracts

Abstract

performance pricing in debt contracts paul asquith massachusetts institute of technology anne beatty the pennsylvania state university joseph weber massachusetts institute of technology march 7, 2002 correspondence to: anne beatty, 215 beam pennsylvania state university, university park, pa 16802. 814-863-0707. alb16@psu.edu. beatty gratefully acknowledges financial support from pricewaterhousecoopers. we wish to thank stan baiman, linda bamber, john core, paul fischer, sp kothari, asis martinez jerez, and jerold zimmerman for helpful comments. we also acknowledge the research assistance of andrea au and jeff braun. finally, we thank the participants of accounting workshops at chicago, duke, georgia, harvard, minnesota, wharton, penn state, george washington, syracuse, and rochester. - 1 - performance pricing in debt contracts abstract in this paper we examine the use of performance pricing in lending contracts and we examine how their use ultimately affects the interest-rate spread charged on the loan. contracts are more likely to include this feature when re-contracting, adverse selection, and moral hazard costs are higher. consistent with performance pricing reducing these costs, after controlling for a selectivity correction and other factors known to affect loan spreads, the spread charged on a loan is 67 to 90 basis points lower when performance pricing is used. these results suggest that performance pricing provides an additional mechanism to other contract features, …

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