LDC Debt: Forgiveness, Indexation, and Investment Incentives

Kenneth Froot, David Scharfstein and Jeremy Stein

No 2541, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We compare different indexation schemes in terms of their ability to facilitate forgiveness and reduce the investment disincentives associated with the large LDC debt overhang. Indexing to an endogenous variable (e.g., a country's output) has a negative moral hazard effect on investment, This problem does not arise when payments are linked to an exogenous variable such as commodity prices. Nonetheless, indexing payments to output may be useful when debtors know more about their willingness to invest than lenders. We also reach new conclusions about the desirability of default penalties under asymmetric information.

Date: 1988-03
Note: ITI IFM
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Published as "LDC Debt: Forgiveness, Indexation, and Investment Incentives." From Journal of Finance, Vol. 44, No. 5, pp. 1335-1350, (December 1989).

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