On the other hand, in an institutions-driven world, where agents are trying to exploit various incentive schemes, it is less obvious that increased risk appetite is as well summarized by reduced credit spreads. Rather, agents may prefer to accept their lowered returns via various subtler nonprice terms and subordination features that allow them to maintain a higher stated yield.
Again, the use of PIK bonds in LBOs is instructive. A long time ago, Steve Kaplan and I did a study of the capital structure of 1980s-era LBOs. 13 What was most noteworthy about the PIK bonds in those deals was not that they had low credit spreads. Rather, it was that they were subject to an extreme degree of implicit subordination.