The Effect Of Performance-sensitive Debt On Investment And Financing Under Taxe-rate Uncertainty

Performance-sensitive debt(PSD)is a new financial instrument of which the coupon payment varies with the firm's performance.In the PSD pricing contract,when the company's operating performance is poor,PSD coupon will increase due to risk compensation.It is the characteristics of coupon changes that encourage effectively the entrepreneur to run an enterprise,maintain the benefits of creditors and improve the firm value,therefore,PSD is very popular in foreign countries,and can bring a lot of benefits to its financial markets,which is worth our domestic capital market reference.Therefore,it is of great practical significance to study the influence of PSD on Chinese capital market in theory.This paper aims to clarify how the PSD under the risk of tax-rate uncertainty impacts on the capital structure of the company based on the corporate capital structure combined with PSD and equity,including changes of the optimal capital structure and the best financing way,the real option value and the optimal investment opportunity.This paper examines the capital structure of a firm that uses PSD financing,which is captured by the level of Earnings Before Interest and Taxes(EBIT).First,we assume the tax rate follows a Poisson process and EBIT follows a geometric Brownian motion.Then,we explicitly derive the equity value and debt value under tax-rate uncertainty by stochastic control theory.Finally,The distinction between PSD and straight debt in the firm value,leverage and yield spreads are illustrated with numerical simulation.Our results show that the optimal performance-sensitivity level can significantly increase firm's value and yield spread of debt under tax-rate uncertainty,but decrease leverage of firm.With the increasing of frequency of tax-rate changing,the effect of PSD is limited.This paper also considers the problem of capital structure based on PSD under the risk of tax-rate uncertainty,and use the stochastic control theory to explicitly derive the value of the option to invest in the project,the value of the optimal bankruptcy level and the optimal investment threshold.Numerical analysis shows the increasing in the expected tax rate and the rate of change in the tax rate will reduce the optimal investment point of the enterprise,the severe macro environment will force enterprises to make decisions on delayed investment;In addition,enterprisesusing PSD to finance can increase their willingness to invest.