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Please use this identifier to cite or link to this item:
http://hdl.handle.net/2451/26453
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| Title: | Performance-Sensitive Debt |
| Authors: | Manso, Gustavo
Strulovici, Bruno
Tchistyi, Alexei |
| Issue Date: | 10-Nov-2005 |
| Series/Report no.: | FIN-05-044 |
| Abstract: | This paper studies performance-sensitive debt (PSD), the class of debt
obligations whose interest payments depend on some measure of the
borrower’s performance. For example, step-up bonds compensate
credit rating downgrades with higher interest rates, and reward credit
rating upgrades with lower interest rates. In an endogenous default
setting, we develop an algorithm to value PSD obligations allowing for
general payment profiles, and obtain closed-form pricing formulas in
important special cases, including step-up bonds. Moreover, we provide a
criterion to compare different PSD obligations in terms of their
efficiency. In particular, we find that step-up bonds lead to earlier
default and lower the market value of the issuing firm’s equity,
compared to fixed-coupon bonds of the same market value. Lastly, we
analyze the implications of our results for the policy of credit-rating agencies. |
| URI: | http://hdl.handle.net/2451/26453 |
| Appears in Collections: | Finance Working Papers
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