Loan Commitments and the Debt Overhang Problem

Christopher Snyder

Journal of Financial and Quantitative Analysis, 1998, vol. 33, issue 1, 87-116

Abstract: The debt overhang problem is shown to arise in the context of an entrepreneurial project that requires a sequence of investments financed by an outside lender. The entrepreneur, not internalizing losses accruing to the lender which financed the initial investments, may inefficiently cancel the project and instead pursue an outside opportunity. It is shown that loan commitments (contracts that allow the entrepreneur to borrow a variable amount at a set interest rate in return for a fixed fee) are the optimal financial contracts in this setting, strictly dominating standard debt. The existence of the fixed fee allows loan commitments to set a relatively low interest rate, improving the entrepreneur's incentives to continue the project. The paper specifies the optimal contract fully, derives robust comparative statics properties (using an extension of Milgrom and Roberts (1994)), and extends the results to more realistic settings (e.g., allowing the market risk-free rate to be stochastic).

Date: 1998
References: Add references at CitEc
Citations: View citations in EconPapers (4)

Downloads: (external link)
https://www.cambridge.org/core/product/identifier/ ... type/journal_article link to article abstract page (text/html)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:cup:jfinqa:v:33:y:1998:i:01:p:87-116_02

Access Statistics for this article

More articles in Journal of Financial and Quantitative Analysis from Cambridge University Press Cambridge University Press, UPH, Shaftesbury Road, Cambridge CB2 8BS UK.
Bibliographic data for series maintained by Kirk Stebbing ().