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

Kirak Kim () and Trang Nguyen ()
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Kirak Kim: Department of Accounting and Finance, Texas A&M University Central Texas, Killeen, Texas 76549
Trang Nguyen: University of Bristol, Bristol BS8 1PQ, United Kingdom

Management Science, 2024, vol. 70, issue 7, 4670-4692

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 postelection. 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.

Keywords: uncertainty; gubernatorial election; debt contract; state-contingent pricing; cost of capital (search for similar items in EconPapers)
Date: 2024
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