Payment-In-Kind (PIK) Definition
When we use products or services to make payment in place of cash, it is said to be PIK (Payment-in-Kind). It also means a financial tool which makes payment of dividends or interest to the stockholders of notes, certificates, bonds, preferred shares with extra securities and capital in place of cash. Those companies like to use PIK securities which do not want to make cash disbursals. They use such outlays in the leveraged buyouts.
A Little More on What is Payment-In-Kind
PIK is a kind of financing known as “Mezzanine Financing”, in which they have features declarative of loan and equity. PIK is likely to make payment of high-interest rates, but at the same time, they involve a great deal of risk. Still, there are investors, who can bear risk-taking more than average, for example, most often, hedge fund organizers and private capital shareholders prefer to make an investment in PIK securities.
The PIK notes provide an opportunity to the issuer to detain paying the dividends in the form of cash. As a return for this holdup, on the note, the issuer, say the bank normally agrees to propose a higher return rate.
To explain the concept of PIK notes function, let’s suppose, an issuer proposes PIK notes of 2 million US dollars to a struggling form. There is a ten percent interest rate on these PIK notes. Their maturity period is almost ten years. They incur two lac US dollars interest every year. However, the financier adds interest to the loan in kind instead of asking the company to make repayment of the principal amount or interest. This makes more loan. Consequently, at the end of the 1st year, the firm is obliged to repay 2.2 million US dollars. This amount keeps increasing until the maturity date of the debt when the cash will be payable.
Most of the time, Payment-in-Kind notes settle with the fraction of a firm’s overall owing loans. The money man structures them so that their maturity period may be later than the firm’s other loans. Hence, the firm is able to pay attention to the repayment of old debts or loans linked to cash dividends faster. But at the same time, it can add extra risk to the money man. In order to cover this risk, many of the money men stipulate an advance payment penalty for increasing the potential income.
PIK also refers to the acceptance of cash substitutes for services or tasks, for instance, a field hand is provided free board and a room as a replacement of getting an hourly pay. This is in an interchange of assisting in the fields. So, this is an illustration of PIK. The IRS (Internal Revenue Service) calls the PIK a ‘bartering income’. The persons, who get earning by bartering, are required to add it in their income tax and report the tax return authorities. Say, a plumber gets some quantity of meat and provides his services in its exchange. He is liable to report the just market value of the meat or his normal fee being his earning on the income tax return.
References for Payment in Kind
Academic Research on Payment-in-Kind (PIK)
Recent developments in corporate finance, Crabbe, L. E., Pickering, M. H., & Prowse, S. D. (1990). Fed. Res. Bull., 76, 593. This paper throws light on the establishment of corporate finance, how it evolved with the passage of time and what are its latest developments.
Controlling financial distress costs in leveraged buyouts with financial innovations, Opler, T. C. (1993). Financial Management, 79-90. Leveraged Buyouts minimize the risk of financial problems. Some of their techniques are strip financing, cash flows, debt provisions, specialist advertisers, covenants, etc. This paper states that these methods were applied in sixty-three LBOs during the timespan of 1987 to 1988. It was a boom of Leveraged Buyouts. The author evaluates these financing techniques in the perspective of the weighted cost of the loan. The adverse impacts of Leveraged Buyouts discussed in 1980 were unfair.
Debt and seniority: An analysis of the role of hard claims in constraining management, Hart, O., & Moore, J. (1994). (No. w4886). National Bureau of Economic Research. The longtime loans control the ability of the management to finance expected investments. Organizations with high loan feel it difficult to increase equity. The authors demonstrate an optimal loan-capital ratio in case of investment which is profitable or having no-profit no-loss. The conditions that allow capital and big long time loans work have been described.
Day-of-the-week patterns in volume and prices of Nasdaq high-yield bonds, Alexander, G. J., & Ferri, M. G. (2000). Journal of Portfolio Management, 26(3), 33-40. This research elaborates the DoW (Day of the Week) structures in prices and volume of the most profitable bonds held by the National Association of Securities Dealers Automated Quotations (NASDAQ).
The new junkyard of corporate finance: the treatment of junk bonds in bankruptcy, Mendales, R. E. (1991). Wash. ULQ, 69, 1137. This paper consists of 6 sections; 1st section explains what are the Junk Bonds. In the 2nd section, the author states the classification issue of loan/capital. Section 3 is about the means of bankruptcy courts. Section 4 provides details of the Junk Bonds types. Section 5 contains information of the ways the bankruptcy must settle the problem related to Junk Bonds. Lastly, in section 6, the author states the challenges of LBOs under the law of fraudulent transfer.
What does Nasdaq’s high-yield bond market reveal about bondholder-stockholder conflicts?, Alexander, G. J., Edwards, A. K., & Ferri, M. G. (2000). Financial Management, 23-39. This paper examines the relation in a company’s stock returns and most profitable public loan returns. It analyses the complicated pattern of differences and similarities of the returns. The positivity dominates the relationship while the negativity shows agency conflicts in the shareholders.
Old wine in new bottles: Subprime mortgage crisis-causes and consequences, Mah-Hui, M. (2008). This research covers the reasons and results of the mortgage crisis in the United States. It has influenced the economy. The author shares the effects of several types of imbalances on rolling bubbles, risks and the ethical hazards.
Concluding Remarks: Why Do Finance? A Comment About Entanglements and Research in the History of Education, Caruso, M. (2015). Nordic Journal of Educational History, 2(1), 141-149. This paper satisfies the question, why do we need to get a loan? The author concludes with his valuable comments on the research made in education’s history.
How to increase the efficiency of bond covenants: a proposal for the Italian corporate market, Bazzana, F., & Palmieri, M. (2012). European Journal of Law and Economics, 34(2), 327-346. Covenants limit business strategies. They are clauses related to the loan agreements with companies. They can solve the problem of interest in the bondholders and the shareholders. However, it demands coordination. The authors present Italian Law and its implementation to set new loan agreements. The consequences of this research have been explained with examples.
Ownership structure, leverage, and firm value: The case of leveraged recapitalizations, Gupta, A., & Rosenthal, L. (1991). Financial Management, 69-83. This paper proposes LR (Leveraged Recapitalization), which is a brief statistical analysis of a comparatively new type of leverage rising transaction. The difference in LR and LBO is that the company stays public, not private. The financial features of the Leveraged Recapitalization companies have been checked. The writers provide evidence in favour of FCF hypothesis (Free Cash Flow) presented by Jensen.