The Role Of Collateral In A Model Of Debt Renegotiation
This paper studies the effect of debt renegotiation on the design of optimal loan arrangements in a model of borrowing and lending with asymmetric information. The optimal form of finance is a standard debt contract with a bankruptcy clause that acts as a payment incentive. Debt renegotiation may occur because bankruptcy involves costly asset liquidation which is ex post inefficient. We show that the extent of the entrepreneur's liabilities in the optimal loan contract depends upon the creditor's commitment to impose bankruptcy should default ever occur. If the creditor is precommitted not to forgive any portion of the outstanding debt, a limited liability arrangement is optimal. That is, default should entitle the creditor to liquidate only the assets remaining from the project that has been financed by the loan. In the absence of precommitment, however, the issuance of debt may efficiently be secured in addition by the entrepreneur's personal wealth outside the project.
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|Date of creation:||1990|
|Contact details of provider:|| Postal: TILBURG UNIVERSITY, CENTER FOR ECONOMIC RESEARCH, 5000 LE TILBURG THE NETHERLANDS.|
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- Hart, O. & Moore, J., 1989.
"Default And Renegotiation: A Dynamic Model Of Debt,"
520, Massachusetts Institute of Technology (MIT), Department of Economics.
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- Douglas W. Diamond, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Oxford University Press, vol. 51(3), pages 393-414.
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- Mathias Dewatripont, 1989. "Renegotiation and Information Revelation Over Time: The Case of Optimal Labor Contracts," The Quarterly Journal of Economics, Oxford University Press, vol. 104(3), pages 589-619.
- Oliver D. Hart & Jean Tirole, 1988. "Contract Renegotiation and Coasian Dynamics," Review of Economic Studies, Oxford University Press, vol. 55(4), pages 509-540.
- Oliver D. Hart & Jean Tirole, 1987. "Contract Renegotiation and Coasian Dynamics," Working papers 442, Massachusetts Institute of Technology (MIT), Department of Economics.
- Barro, Robert J, 1976. "The Loan Market, Collateral, and Rates of Interest," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 8(4), pages 439-456, November.
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- Laffont, Jean-Jacques & Tirole, Jean, 1988. "The Dynamics of Incentive Contracts," Econometrica, Econometric Society, vol. 56(5), pages 1153-1175, September.
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- Douglas Gale & Martin Hellwig, 1985. "Incentive-Compatible Debt Contracts: The One-Period Problem," Review of Economic Studies, Oxford University Press, vol. 52(4), pages 647-663. Full references (including those not matched with items on IDEAS)
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