Debt Contracting When Borrowers Face Transitory Uncertainty: Evidence from U.S. Gubernatorial Elections

Kirak D Kim, Trang Nguyen

Research output: Contribution to journalArticle (Academic Journal)peer-review

41 Downloads (Pure)

Abstract

We study debt-contracting implications of uncertainty surrounding U.S. gubernatorial elections. In election years, loan contracts are more likely to include performance-pricing provisions, whereas loan spreads are mostly unaffected. Additionally, we find, only among those loans without performance-pricing provisions, a marginal increase in loan spreads in election years and a significant increase in loan-spread amendments post-election. The results suggest that under transitory uncertainty, performance pricing curbs an explicit rise in loan spreads and reduces ex-post renegotiations, yielding efficiency gains in contracting. Our further analysis uncovers a veiled pricing effect manifested through interest-rate contingencies: The likelihood of using rate-increasing pricing grids rises in election years for borrowers with a high exposure to uncertainty, thereby ensuring compensation to lenders for uncertainty. Overall, our findings suggest that loan contracting attempts to mitigate the problem of election uncertainty and renegotiation costs through state-contingent pricing, with which borrowers weigh initial loan spreads against the potential for loan-spread variability in the future.
Original languageEnglish
JournalManagement Science
Early online date15 Sept 2023
DOIs
Publication statusE-pub ahead of print - 15 Sept 2023

Fingerprint

Dive into the research topics of 'Debt Contracting When Borrowers Face Transitory Uncertainty: Evidence from U.S. Gubernatorial Elections'. Together they form a unique fingerprint.

Cite this