When Is (Performance-Sensitive) Debt Optimal?

Alex Edmans

No 16433, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: Existing theories of debt consider a single contractible performance measure ("output"). In reality, many other performance signals are also available. It may seem that debt is no longer optimal; for example, if the signals are sufficiently positive, the agent should receive a payment even if output is low. This paper shows that debt remains the optimal contract under additional signals -- they only affect the face value of debt, but not the form of the contract. We show how the face value should depend on other signals, providing a theory of performance-sensitive debt.

Keywords: Informativeness principle; Limited liability; Performance-sensitive debt (search for similar items in EconPapers)
JEL-codes: D86 G32 G34 J33 (search for similar items in EconPapers)
Date: 2021-08
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