Cash management and risk-taking incentives with performance-sensitive debt under stochastic financing conditions

Abstract

We build a model of cash management for financially constrained firm with performance-sensitivity debt (PSD) in a stochastic financing conditions framework. In this model, stochastic financing conditions lead shareholders to have incentives for risk-taking. This paper highlights the implications of PSD on cash management and risk-taking incentives for shareholders. We find that firms with PSD issue equity earlier, and delay payout to shareholders relative to firms with straight debt. In addition, we also discover that larger performance-sensitivity leads shareholders to have stronger risk-taking incentives.