Optimal Debt Contracts with Renegotiation

22 Pages Posted: 18 Oct 2004

See all articles by Murat Usman

Murat Usman

Koc University - Department of Economics

Abstract

This paper studies the role of debt in committing a seller not to trade at a low price. We consider a discrete-time finite-horizon buyer-seller relationship. The seller makes an upfront relationship-specific investment, which is financed with debt. Debt then is repaid gradually to mitigate the hold-up risk. Even though debt is renegotiable, under the assumption that with a small probability renegotiation may fail and may lead to inefficient liquidation, debt still can be used as a commitment device. We solve for renegotiation proof dynamic debt contracts that are optimal for the seller and show that debt is repaid over the entire course of the relationship with declining repayments.

Suggested Citation

Usman, Murat, Optimal Debt Contracts with Renegotiation. Available at SSRN: https://ssrn.com/abstract=605186

Murat Usman (Contact Author)

Koc University - Department of Economics ( email )

Rumeli Feneri Yolu
College of Administrative Sciences & Economics
Sariyer 80910, Istanbul
Turkey
+90 212 338 1553 (Phone)
+90 212 338 1653 (Fax)

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