Interest Rates and the Design of Financial Contracts

62 Pages Posted: 26 May 2020 Last revised: 23 Apr 2021

See all articles by Michael R. Roberts

Michael R. Roberts

The Wharton School - University of Pennsylvania; National Bureau of Economic Research (NBER)

Michael Schwert

University of Pennsylvania - The Wharton School

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Date Written: May 2020

Abstract

We show that variation in short-term nominal interest rates produces an endogenous response in the design of and commitment to corporate loan contracts. Interest rates are negatively related to the cash flow rights and positively related to the control rights granted to creditors. An implication of this contractual response is a sharp increase in the ex post renegotiation of contracts originated in low interest rate environments, as well as a muted effect of interest rate variation on the cost of debt capital. Our findings illustrate how the design of financial contracts in practice reflects a multi-dimensional tradeoff among contract features that aligns incentives and apportions risk among the contracting parties in a state-contingent manner.

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Suggested Citation

Roberts, Michael R. and Schwert, Michael, Interest Rates and the Design of Financial Contracts (May 2020). NBER Working Paper No. w27195, Available at SSRN: https://ssrn.com/abstract=3609647

Michael R. Roberts (Contact Author)

The Wharton School - University of Pennsylvania; National Bureau of Economic Research (NBER) ( email )

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Michael Schwert

University of Pennsylvania - The Wharton School ( email )

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