Abstract
This paper internalizes a new approach to measure the direct and pure impact of credit rating changes on the cost of debt. We analyze loan contracts with rating-based performance pricing (RBPP) provisions. They ex ante link interest spreads to the credit ratings. We examine a large sample of private loan contracts from North-American lenders between 1993 and 2008. 16% of these loans contain RBPP provisions. Borrowers agreeing to RBPP provisions observe initial spread reductions between 20 and 40 basis points. A one-notch rating deterioration is (in absolute terms) most expensive around and below investment grade boundary. A one-notch downgrade leads to a spread increase (over reference rate) by 20% to 30%. An average borrower rated below BBB with one average RBPP contract would be willing to spend more than $8 million for being upgraded one single rating notch.
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