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BENCHMARKS FOR THE EFFICIENT DESIGN OF A PERFORMANCE PRICING GRID IN DEBT CONTRACTS
Abstract
Large syndicated debt contracts regularly include accounting-based performance pricing provisions that provide firms incentives to manage these measures around the pricing thresholds tied with the interest rate charged on a loan. To examine this inefficiency the study develops a theoretical model that formally analyzes trade-offs between the costs and benefits of discretionary reporting and employs methods of empirical analysis to test predictions of the model. Results of the study indicate that more careful design of pricing grid parameters reduces incentives for discretionary management of reported financial ratios around pricing grid thresholds while maintaining relationship between interest rate and borrower's creditworthiness. More specifically, study proposes benchmark values for the change in the interest rate spread across pricing grid levels and presents guidelines on the performance pricing grid design.
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