Differences in Selection and Manipulation of Alternate Performance Pricing Measures

Performance pricing (PP) is a feature of loans that allows for dynamic changes in rates in response to changes in the credit risk of the borrower without the need for costly renegotiation or default. This provides management with an incentive to manipulate its accounting measures and the information it provides credit-reporting agencies to lower its interest rate. In response, banks are likely to select contracts to take into account the possibility of manipulation or its effects on rates. Unlike in previous earnings management studies, this is a setting in which the manipulation has a direct effect on firm cash flows. I find corporate governance is associated with borrowers receiving accounting-based PP loans. I also find the choice of accounting-based PP loans may be associated with greater levels of abnormal accruals (at the .10 level) while the choice of PP loan is not significantly associated with more income-increasing accounting choice changes. Finally, I find the choice of ratings-based PP loans is associated with lower spreads over time.