Close window

 

PERFORMANCE SENSITIVE DEBT – THE EFFECT
ON RENEGOTIATIONS, LEVERAGE, AND
DIVIDEND POLICY

Tor Åge Myklebust1
Norwegian School of Economics, NHH, Norway
 



ABSTRACT
Performance sensitive debt (PSD) contracts link the paid interest rate
to a measure of firm performance. Using a simple trade-off model
incorporating optimal leverage, endogenously determined debt
renegotiations, and PSD, I show that firms using PSD would choose
to renegotiate their debt earlier compared to firms using regular
fixed rate debt. In other words, debt that makes a firm pay higher
interest rates in times when cash flow is low, increase the probability
of renegotiation. My result challenges the hypothesis that PSD
contracts are used to prevent renegotiations, and supports recent
empirical findings by Roberts & Sufi (2009). The model also provides
testable predictions on dividend policies and leverage.