Performance-Sensitive Debt
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Manso_Performance-Sensitive.pdf
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Author(s) • •
Manso, Gustavo
Strulovici, Bruno
Tchistyi, Alexei
Date Issued
March 2011
Journal
Review of Financial Studies
Publisher
Oxford University Press
Citation
Manso, G., B. Strulovici, and A. Tchistyi. “Performance-Sensitive Debt.” Review of Financial Studies 23.5 (2010) : 1819-1854.
Version
Author's final manuscript
Abstract
This article studies performance-sensitive debt (PSD), the class of debt obligations whose interest payments depend on some measure of the borrower’s performance. We demonstrate that the existence of PSD obligations cannot be explained by the trade-off theory of capital structure, as PSD leads to earlier default and lower equity value compared to fixed-rate debt of the same market value. We show that, consistent with the pecking-order theory, PSD can be used as an inexpensive screening device, and we find empirically that firms choosing PSD loans are more likely to improve their credit ratings than firms choosing fixed-interest loans. We also develop a method to value PSD obligations allowing for general payment profiles and obtain closed-form pricing formulas for step-up bonds and linear PSD.
MIT Department
Sloan School of Management
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Creative Commons Attribution-Noncommercial-Share Alike 3.0
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DOI of Published Version
https://doi.org/10.1093/rfs/hhq005