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The Role of Debt in Procurement Contracts

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  • Yossef Spiegel

Abstract

This paper develops a theory of capital structure based on the attempts of a firm to alleviate a holdup problem that arises in its bilateral relationship with a buyer. It is shown that by issuing debt to outsiders, the firm can improve its ex post bargaining position vis-a-vis the buyer and capture a larger share of the ex post gains from trade. Debt, however, is costly because the buyer may find the required price too high and refuse to trade. Since debt raises the payoff of claimholders, it strengthens the firm's incentive to make relationship-specific investments, and therefore alleviates the well-known underinvestment problem. A comparative static analysis yields a number of testable hypotheses regarding the firm's financial strategy. Copyright 1996 The Massachusetts Institute of Technology.

Suggested Citation

  • Yossef Spiegel, 1996. "The Role of Debt in Procurement Contracts," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 5(3), pages 379-407, September.
  • Handle: RePEc:bla:jemstr:v:5:y:1996:i:3:p:379-407
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    Cited by:

    1. Sarah Parlane, 2003. "Procurement Contracts under Limited Liability," The Economic and Social Review, Economic and Social Studies, vol. 34(1), pages 1-21.
    2. João Teixeira, 2014. "Outsourcing with debt financing," Portuguese Economic Journal, Springer;Instituto Superior de Economia e Gestao, vol. 13(1), pages 1-24, April.
    3. David Martimort & Flavio Menezes & Myrna Wooders & DANIEL DANAU & ANNALISA VINELLA, 2015. "Public-Private Contracting under Limited Commitment," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 17(1), pages 78-110, February.
    4. Fay,Marianne & Martimort,David & Straub,Stephane, 2018. "Funding and financing infrastructure : the joint-use of public and private finance," Policy Research Working Paper Series 8496, The World Bank.
    5. Fraja, Gianni De & Piga, Claudio A. G., 2004. "Strategic debt in vertical relationships: theory and evidence," Research in Economics, Elsevier, vol. 58(2), pages 103-123, June.
    6. Usman, Murat, 2008. "Commitment with renegotiable debt contracts and verifiable cash flow," Economics Letters, Elsevier, vol. 99(2), pages 249-251, May.
    7. Yair Tauman & Yoram Weiss & Chang Zhao, 2017. "Bargaining in Patent Licensing with Inefficient Outcomes," Department of Economics Working Papers 17-04, Stony Brook University, Department of Economics.

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